British American Tobacco’s (LSE: BATS) share price is trading at tempting levels right now. Its average price in February is over 30% lower than the highest price level seen in the past year. In my view, as a FTSE 100 company with a long history, robust financials and captive demand, it’s a no-brainer that the time is still ripe to buy its shares.
However, the big question in my mind when researching this stock was: how long should investors hold it for? The trigger for the question is the small changes under way that will fundamentally alter the industry over time. Just as I wrote about the oil and gas industry as far as Royal Dutch Shell was concerned, changing consumer preferences and regulatory changes will push the tobacco industry into a tipping point as well.
Here at the Motley Fool, we are interested in investment opportunities that can hold you in good stead for the long term, so it is essential to assess what industry evolution means for tobacco majors like British American. My research indicates that it’s a good share to hold for the next few years, but the long-term future needs more consideration. Let me explain.
Regulatory wrangle
One factor sending the company’s share price down is the potential regulatory clampdown on menthol cigarettes by the US Food and Drug Administration (FDA). British American’s US market for menthols accounts for 25% of overall group profit, indicating a significant hit to the bottom line if the regulatory changes do go through. And electronic cigarettes might not be the safety net they seem. The FDA is also looking to limit the use of e-cigarettes, to curb consumption among young people.
The menthols situation will be challenged by tobacco producers and it could be a good few years before the ultimate outcome is determined. And on the question of smoking alternatives, it’s worth noting that relatively little revenue is presently generated from next-gen electronic products. Restricting their usage could even prolong dependence on traditional cigarettes, boosting the core strength of the company.
Positives to the rescue
For the foreseeable future, British American remains in a fairly strong position with a still-large cigarette market, I believe. It also has strong financials, with a year-on-year increase in both revenues and profits in 2017 (the last full year for which figures are available). It’s highly geographically diversified too, easing macro-economic risks that might come from a concentrated market. And we cannot ignore its highly attractive forward price/earnings ratio of 2.2x, way lower than that of its peers.
Making sense of the future
However, over the long term, the outlook is less clear. The outcome of regulatory changes and how far the company is able to gain share in the next-gen products market are still unknown. What we do know, is that it expects “a very significant percentage of the group revenue” will come from these products by 2030. At worst, therefore, it’s a wait and see and at best a positive long-term scenario. I would go ahead and buy.
