Some might have ethical objections to the tobacco industry. But from an investing perspective, I find it hard to fault British American Tobacco (LSE: BATS). I’d even rate it one of my top FTSE 100 stock picks for a long-term pension plan. The company has been offering a reliable progressive dividend for years, and forecasts currently indicate yields around the 8% mark.
A pre-close update Wednesday spoke of the firm’s strategic priorities. The key seems to be growing its share of what it calls ‘New Categories’. That’s products that don’t involve combustible tobacco, thus reducing the associated health risks. BATS says the first half has seen continuing strong growth in that market. And it sounds like the strength is extending into the second half too.
The bulk of profit is still coming from cigarettes though, and that’s holding up well. We are in the midst of a global reduction in smoking, but it looks softer than previously thought. The global volume of cigarettes and similar products is now expected to decline by a relatively moderate 5% this year. The industry had earlier been expecting a drop of 7%.
Weak market reaction
The BATS share price trailed the rest of the FTSE 100 in early trading, though it did come back fairly quickly. But on a morning when most of the Footsie is green with very few shares in the red, it’s a little disappointing. It’s in spite of the company’s reiteration of its earlier guidance too. Adjusted revenue growth, at constant currency, should be at the high end of the 1-3% range. And we should see mid-single figure adjusted EPS growth.
The biggest downside for me is debt. British American is working to get its net debt to EBITDA multiple down, which is a good thing. But its target is a fairly high 3x. That’s around twice my rule-of-thumb comfort level. I can handle worse than that for a company with a clear view of future income, but I’m still a bit twitchy.
Maybe the most important snippet from a pension viewpoint concerns the BATS dividend. The company has confirmed a “dividend payout ratio of 65% of adjusted diluted EPS and growth in sterling terms, supported by a strong liquidity position.” Hopefully, that strong liquidity position will also help towards getting debts down further.
FTSE 100 for pensions
When it comes to providing for my retirement, I rate FTSE 100 dividends above all else. And those buying now could be locking in a healthy income stream, thanks to the market turning against tobacco shares.
The British American Tobacco share price is down 10% in 2020, though the Covid-19 impact on the firm looks fairly minimal. Over the past five years, the negativity is more apparent. BATS shares are down 20% on a timescale that’s seen the FTSE 100 gain 11%.
We’re looking at P/E multiples of only around eight now. I think that seriously undervalues the long-term income stream coming from BATS. Smoking tobacco might be slowly losing its popularity. But with alternatives growing nicely, I think the long-term future for tobacco will be cash rich. And that’s exactly what I want from a FTSE 100 pension investment.
