Tobacco stocks have been profitable investments in recent years. British American Tobacco (LSE: BATS) has risen by more than 60% over the last five years, during which its dividend has risen by 29%.
However, growth isn’t the only reason to own tobacco stocks. Another key attraction is the defensive quality of these firms — their ability to provide stable returns even in tough times. This makes them a good hedge to the cyclical stocks in our portfolios, whose returns tend to be more variable.
In this article I’m going to catch up on the latest trading figures from BAT and consider the appeal of a cyclical FTSE 100 stock with an affordable valuation and a 5.4% yield.
Outperforming the industry?
BAT’s acquisition of Reynolds American earlier this year is another step in the firm’s mission to consolidate the industry, cut costs and boost profits even as global tobacco sales fall.
This plan seems to be working. Management expects industry-wide sales volumes to have fallen by 4% in 2017, but expects BAT sales to have fallen by less than this as it gains market share.
However, pricing power in markets such as Russia is said to have become “more difficult” this year. The company has also seen some customers trade down to cheaper brands following significant increases in excise duty in a number of Middle Eastern markets.
Despite this, profits are expected to be in line with expectations, helped by a 5% tailwind from favourable exchange rate movements.
Cheap enough to buy?
The shares have now fallen by around 10% from this summer’s peak of more than £55. In my view, this stock is starting to look more reasonably priced again.
Analysts expect earnings per share to rise by at least 10% this year, and in 2018. On this basis, I think the stock’s 2018 forecast P/E of 16.3 and prospective yield of 4% look reasonable. In my view, BAT remains a tempting choice for long-term income investors.
A discount I can’t ignore
A stock in my own portfolio is mining group Anglo American (LSE: AAL). I’ve held onto these shares and in fact have bought more this year, as the company’s performance has been better than expected.
Despite this, the firm’s shares still trade at a notable discount to its two main rivals, Rio Tinto and BHP Billiton. For example, Anglo’s business is valued at 1.2 times its book value, compared to 2 times for Rio and 1.7 times for BHP.
One reason for this is the political and operational risks faced by Anglo American’s operations in South Africa. Another consideration is that historically, this business has been less profitable than its rivals.
Despite this, I think Anglo’s discounted valuation is still too cheap to ignore. Net debt has halved since the end of 2015 and the group’s shares currently trade on just six times its trailing 12-month free cash flow. That’s much cheaper than the firm’s two big rivals.
Having turned around the business, I believe Anglo’s management will now be focused on demonstrating the value in its assets. I continue to rate the shares as a buy.
