Today’s quarterly update from British American Tobacco (LSE: BATS) (NYSE: BTI.US) was encouraging. It showed that the company’s cost-cutting programme is having a positive impact on the bottom line, with operating margins increasing by 30 basis points. Furthermore, the company’s global drive brands continue to increase their market share and, despite continued falls in the volume of cigarettes sold, the top line increased by 3% at constant exchange rates. With investment of $4.7 billion in the enlarged Reynolds American group, British American Tobacco looks set to maintain its exposure to a key marketplace, which is good news for shareholders.
Looking Ahead
Of course, the future is uncertain for British American Tobacco and for sector peer, Imperial Tobacco (LSE: IMT). That’s because there are significant changes taking place in the tobacco sector, with e-cigarettes continually increasing in popularity and being a key contributor to the previously mentioned volume declines in cigarettes that the two companies (and the wider sector) are experiencing.
However, on this front, both British American Tobacco and Imperial Tobacco are well positioned to benefit. Although the e-cigarette industry is highly fragmented, they both have offerings in that space, with British American Tobacco’s Vype brand having been around for over a year and said to be making good progress according to today’s update. Meanwhile, Imperial Tobacco’s Puritane is also gaining popularity and increasing its distribution to what could turn out to be a strong growth sector for both companies over the medium to long term.
The Investment Case
In the meantime, British American Tobacco and Imperial Tobacco offer a potent mix of value, yield and growth potential. Although volumes are declining, improved pricing combined with cost reductions mean that both companies are set to increase earnings per share (EPS) by high single-digits next year, which is expected to have a positive impact on dividend growth. Indeed, despite already yielding 4.1% (British American Tobacco) and 4.9% (Imperial Tobacco), dividends per share are forecast to grow by 7.3% (British American Tobacco) and 9.3% (Imperial Tobacco) next year alone.
No-Brainers
So, strong earnings and dividend growth prospects are on offer at both companies. What makes them no-brainers, however, is their stability. Unlike the vast majority of companies in the FTSE 100, the two tobacco companies have an earnings profile that is hugely stable. Their customers are extremely loyal, both to the product and to the brands they smoke, and even if there is a recession British American Tobacco and Imperial Tobacco should be able to grow earnings and dividends at impressive rates.
