Tobacco stocks have proven to be a remarkably reliable investment given the social and political pressure on smoking – especially in the developed world. Back in November though, the industry seemed to be dealt another huge blow as it emerged the US authorities were considering banning menthol cigarettes. Particularly hard hit was British American Tobacco (LSE: BATS).
Trying to make it big in America
The tobacco company’s share price was hit hard by the potential crackdown in the USA because menthol cigarettes account for around 36% of the market there and BATS last year made a $47bn acquisition of Pall Mall-owner Reynolds American, which makes it a leader in menthol cigarettes. The shares have continued to slide since the announcement and many brokers have slashed their forecasts for the price, that’s despite the company saying since that it has continued to perform “well“, with its full-year guidance remaining unchanged.
What’s clear is that any change in the United States won’t come in for some time – quite possibly two or more years, giving BATS plenty of time to prepare and very likely lobby to reduce the impact on the business. Given that tobacco companies have lived under the constant threat of regulation, they are well versed in making their case to legislators to protect their interests, so this isn’t the biggest threat to their existence that they’ve faced.
The dark days will end
With a dividend yield comfortably over 7% and a P/E ratio a little under 10, in many ways BATS already looks good value to investors looking for income and seeking a company that has been knocked down – most likely only temporarily. The share price has been hammered in the year to date and has fallen by around 47%, although the sharpest decline has been seen since early November in the wider market malaise.
Looking back to the half-year report, there’s a clear picture of good momentum within the business which contrasts with the falling share price – and I think it should therefore likely recover at some point. Revenue for the six months to 30 June, was up 56.9% on the same period the year before while net cash increased by a mega 126.1%, although on the downside, earnings per share fell slightly.
The combination of a low P/E ratio and a high dividend yield does, I think, indicate there’s value in BATS right now. The share price may continue to fall – especially as the market overall is volatile and declining. But eventually, strong companies with a product people want or believe they need do come back into fashion and their share prices rise. I don’t see a reason why the threat of restrictions in America this time will cause the company a problem any different to those it has overcome before. The industry as a whole is adept at dealing with change and within the tobacco industry, BATS – especially after the acquisition of Reynolds American – is a major player.
