With interest rates being relatively low, now seems to be an opportune moment for companies from multiple sectors to engage in bid activity. The tobacco sector is no different, with American tobacco companies Lorrillard and Reynolds merging. This could cause the combined group to sell off assets so as to comply with competition commission rules, with Imperial Tobacco (LSE: IMT) said to be the favourite to clinch the deal.
Of course, the merger affects investors in British American Tobacco (LSE: BATS), since it owns 42% of Reynolds. However, putting the merger to one side, big tobacco stocks continue to offer long-term potential and could make a positive impact on your portfolio.
Super Yields
For many income-seeking investors, consistency is key. Certainly, a 5%+ yield is great, but a lower and more reliable yield is often more lucrative to income-seekers. Imperial Tobacco’s yield of 4.7% and British American Tobacco’s yield of 4.1%, although not the highest in the FTSE 100, are well covered and offer strong growth rates.
Indeed, Imperial Tobacco’s dividend is covered 1.6 times by earnings, while British American Tobacco’s dividend is covered 1.5 times by profits. Furthermore, Imperial Tobacco is expected to increase dividends per share by 9.2% next year, while British American’s dividends per share are set to rise by 7.3% — both of which are well ahead of inflation.
Growth Prospects
A key reason to avoid tobacco stocks has always been the evolution of consumer tastes. For example, consumers are generally becoming more health-conscious and this is, to an extent, being reflected in lower cigarette sales in developed markets. Certainly, counterfeit cigarettes have also been a factor, but it appears as though smoking tobacco is on the decline, as a mixture of social and regulatory changes are having an impact.
However, lost growth in cigarettes could be replaced by e-cigarette sales, with the smokeless tobacco industry already being worth over $1 billion. Indeed, e-cigarettes are proving popular among young consumers in particular and seem to offer a potential catalyst to increase the bottom lines of Imperial Tobacco and British American Tobacco, both of whom have been quick to release their own lines of e-cigarettes.
Looking Ahead
Both companies appear to offer investors strong growth prospects. As well as the aforementioned dividend growth, Imperial Tobacco and British American Tobacco are set to increase earnings per share (EPS) by 4% and 8% respectively next year, while price to earnings (P/E) ratios of 13.5 (Imperial Tobacco) and 16.7 (British American Tobacco) do not appear to fully reflect the potential on offer. As such, both Imperial Tobacco and British American Tobacco could add value to your portfolio.
