There’s a lot to worry investors holding British American Tobacco (LSE: BATS) shares. But it doesn’t mean bargain hunters and income-seekers should necessarily stay away.
Ignoring the appealing dividend yield for the moment, the fundamentals of this recession-resistant giant are appealing to me.
Firstly, it is finally out of Russia. There’s been criticism that this has taken far too long — it’s been 18 months since Ukraine was invaded — but the Russian market accounted for approximately 2.7% of group revenue and 2.5% of group adjusted profit from operations. Finding a buyer for such an operation — and securing a decent price when the world knows you’re a forced seller — was never going to be a quick and easy process.
A dividend that’s hard to ignore
That dividend. Yes, interest rates are on the rise and cash is holding more appeal than a few months ago. But it’s impossible to ignore an 8.9% dividend.
With all dividends, the value is in the future not the past. So we can’t just look at what they’ve paid in the past, we need to know if they can pay in the future. Through this lens, British American Tobacco is a solid choice. It has made dividend payments a priority in the past, and with the cash influx from the sale of the Russian arm, it has the cash to continue this trend.
We’ve seen two dividend payments so far this year and can fairly expect the same again. The first quarter’s payment of 57.25p per share was generous in March when the shares had just traded for over 3,000p. Getting the same income now the shares are hovering around 2,585p feels like a steal.
So the income is pretty tempting but it’s the capital return that really appeals to me.
Obscenely good value
The price-to-earnings (P/E) ratio alone would merit a lot of interest from value investors. When the market value price per share is less than 20 times the company’s earnings per share, we know we’re on comfortable ground. Any P/E ratio under 15 is interesting to a value investor and under 10 is rare.
British American Tobacco shares are currently trading on a P/E ratio of 6.6x.
Imperial Brands, its closest rival, is trading on 9.3x. Not unappealing but its half-hearted forays into smokeless alternatives make me reluctant to reach for my wallet.
Smokeless options are becoming more important in the tobacco sector. The UK government is aiming to be ‘smoke-free’ by 2030, so without adaptation these sin stocks will lose a significant market. British American Tobacco has been leading the transition into vaping and owns Vuse, the number one vaping brand in the world.
Buying the shares?
Sin stocks like this aren’t for everyone. Aside from the morality of investing in alcohol, gambling or tobacco, these businesses are at risk of tightening legislation that could throttle or totally wipe out their core business.
It’s a large shadow for British American Tobacco to operate under. But the dividend, product diversification and shockingly low P/E ratio mean I’m still tempted to add to my portfolio.
