Morgan Stanley just took a huge hike to its price target for British American Tobacco (LSE: BATS) shares. A previous target of 3,050p was upgraded all the way to 4,900p. And that leap of around 60% marked a significant U-turn. The new rating of Overweight signals the analyst is expecting bright things. It calls the stock its “top pick in European tobacco”.
Pair this with a blockbuster dividend and a valuation on the cheap side and you’ve got what I’ve been saying for years — there could be plenty of life in the old dog yet. I suspect British American Tobacco could turn out to be one of those rarest of stocks that offer above average dividends along with big growth in share price.
Icing on the cake
To start with, the price target change was absolutely massive. What was the justification? What did Morgan Stanley like so much?
For one, the defensiveness of the category was highlighted. Tobacco sales tend to be inflation-resistant. The stickiness of the products often means tough economic times are more easily weathered.
A second point was its cash generation. British American Tobacco makes tons of money. And that means large dividends (a 5.67% yield is on offer at the moment) might continue rising in the years ahead.
A third point in the analysis was its undemanding valuation. A price-to-earnings ratio of 12 is well below the FTSE 100 average and compares very favourably with American competitors.
But the icing on the cake, for me, was the mention of the positive progress of non-combustibles. That means vapes and the like. These non-smoking alternatives really may be able to offset a future in which ciggies are even more on the decline.
Is it a buy?
That’s plenty of positives, so it’s likely worth looking at the negatives too. One obvious drawback for potential investors is the ethical dilemma of investing in a ‘sin stock’. Tobacco causes health issues and that’s not something many people will feel comfortable with.
Following on from that, the lowering consumption and possible outright ban of such products has to be considered too. The UK and New Zealand have already made steps to make smoking not long for this world. This could mean the business as a whole has a shelf life.
On the other hand, I think it’s worth pointing out that the demise of cigarettes has been predicted. But many of the businesses in the sector don’t seem to have been worried.
Here’s an interesting factoid. Which of the FTSE 100 companies on the index when it began in 1984 has made the best investment? You guessed it, British American Tobacco.
Perhaps the next 40 years will be more fruitful for the company than the doomsayers predict. I think it’s worth considering.
