The Pros And Cons Of Investing In British American Tobacco plc

Stock market selections are never black-and-white decisions, and investors often have to plough through a mountain of conflicting arguments before coming to a sound conclusion.

Today I am looking at British American Tobacco (LSE: BATS) (NYSE: BTI.US) and assessing whether the positives surrounding the firm’s investment case outweigh the negatives.

Cigarette demand continues to slide

A backdrop of sustained pressure on consumers’ wallets, and the effect of wider health and social factors on smokers’ habits, has seen the outlook for the tobacco sector gradually deteriorate in recent times. Indeed, research house Key Note reports that, as of 2011, only 20% of the UK adult population smoked, falling from 27% in 2000 and 45% in 1974.

British American Tobacco warned in October’s trading update of “industry volume declining and difficult trading conditions persisting in some parts of the world,” with patchy performance in developing markets — home to around 80% of the world’s smokers — becoming particularly worrisome.

Revenues continue to march higher

Despite the bleak outlook for tobacco demand, however, the firm’s stable of premier brands — which comprises the likes of DunhillPall Mall and Lucky Strike has enabled British American Tobacco to keep revenues ticking higher. Group revenues rose 3.5% during January-September, at constant exchange rates, even though volumes drooped 3.2% to 501bn cigarettes during the period.

The company’s top-tier labels carry formidable pricing power that enable the firm to keep growing the top line. Bucking weakness across its subsidiaries, the brand strength of these Global Drive Brands drove volumes 1.9% up in the period.

Regulatory concerns ratcheting higher

Make no mistake: cigarette companies are fighting a losing battle when it comes to dealing with anti-smoking legislation being introduced across the globe. Legal moves to introduce plain cigarette packaging in New Zealand and Ireland, possibly as soon as 2014, has been hotting up in recent weeks.

Meanwhile, reports that lawmakers in China are stepping up plans to prohibit public smoking in the country serves as a grim reminder to tobacco firms of changing attitudes in emerging regions. And in the e-cigarette market — widely identified as the next mammoth growth area for the world’s smoking specialists — news that European Union legislators are planning for the strongest products to require authorisation as a medicine represents yet another potential roadblock to future earnings  growth.

Monster dividends keep on rolling

Still, a backdrop of rolling earnings growth has allowed British American Tobacco’s progressive dividend policy to continue pulling up trees, and last year’s 134.9p per share payout was up more than 60% from levels punched five years earlier.

And City analysts expect the dividend to rise to 142.5p and 151.2p in 2013 and 2014 respectively, payments that would create meaty yields of 4.6% and 4.8%. With British American Tobacco in great shape to achieve further expansion well into the future, I believe that the cigarette giant is a great pick for those seeking top-notch growth and income prospects.

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> Royston does not own shares in British American Tobacco.