The last six months have been particularly strong for British American Tobacco (LSE: BATS) (NYSE: BTI.US), with the company’s share price rising by 11% while the FTSE 100 is flat over the same period. However, there could be more to come from the tobacco major and its shares could be worth 4084p. Here’s why.
Long-Term Potential
Clearly, smoking cigarettes is becoming less popular in developed nations as regulatory restrictions on the activity as well as social changes have meant that fewer people now smoke. However, in recent years there has been an explosion in the popularity of ‘smokeless tobacco’ products such as e-cigarettes that contain nicotine, but not the tar and chemicals found in ‘normal’ cigarettes. As a result, they are believed to be less bad for people’s health and, at least partly because of this, they are becoming increasingly popular — especially among younger people.
This presents a huge opportunity for tobacco companies and for British American Tobacco in particular. That’s because it has invested heavily in its Vype e-cigarette line, with the product having been on sale for over a year. It has therefore stolen a march on many of its rivals and gained a foothold in the $1 billion industry. This could help to deliver a stronger growth rate for British American Tobacco moving forward.
A Top-Notch Yield
As well as growth potential, British American Tobacco also offers investors great income prospects. At present, shares in the company yield a very attractive 4.2%, which is considerably higher than the FTSE 100’s yield of around 3.5%. However, there is scope for British American Tobacco to be a lot more generous when it comes to dividend payments. Indeed, its payout ratio (the proportion of profits paid out as a dividend) is just 69%. Certainly, British American Tobacco needs to invest in new plant and machinery, but as a mature company in a very mature industry, it appears to have the scope to pay out a greater proportion of profit as a dividend.
For instance, if it were to pay out 75% of profit as a dividend and still yield a very attractive 4.2%, it would mean shares in the company trading around 7% higher than their current level. In addition, British American Tobacco is forecast to increase dividends per share by 7.4% next year, which is being funded by earnings growth of 8% rather than a higher payout ratio. Applying a higher payout ratio to next year’s higher dividend (and maintaining the same yield of 4.2%) would mean shares in British American Tobacco would trade at 4084p, which is 15.5% higher than the current price of 3537p.
Looking Ahead
While a rise of 15.5% may not sound too much, British American Tobacco is a hugely consistent company when it comes to earnings and dividend growth. Therefore, over the longer term (and with a potential boost from e-cigarette sales), shares could go much higher. Over the medium term, though, a rise of 15.5% looks very achievable and, when added to a yield of 4.2%, means that a total return of over 20% is a realistic goal for investors in the company.
