How Much Higher Can British American Tobacco plc Go?

Right now I’m looking at some of the most popular companies in the FTSE 100 and wider market to try and establish which direction their shares are likely to move.

Today I’m looking at British American Tobacco (LSE: BATS) (NYSE: BTI.US) to ascertain if its share price will continue to rise.

Market sentiment
british american tobacco / imperial tobacco

At present, the market appears to be excited about British American’s future, mainly because of developments overseas.

Specifically, it has recently been revealed that the company has hired bankers to advise on potential multi-billion pound acquisition opportunities within the US. Two targets in particular are British American’s smaller, US-listed tobacco peers, Lorillard and Reynolds American.

Rumours of a possible deal have been present for some time. You see, British American acquired a 42% stake in Reynolds American a decade ago. At the time, British American was forced to sign an agreement preventing the company from increasing its position for ten years. This agreement ends in July.

The obvious option is for British American to acquire Reynolds, however, there has speculation that Reynolds will bid for smaller peer Lorillard, which is likely to make things even more complicated.

Still, one thing is for sure, regardless of which option British American takes, a deal between any of the companies would be the biggest deal the tobacco sector has seen in years. Reynolds’ market value currently stands at $31bn and Lorillard’s is $22bn.

Nevertheless, the market seems to be pleased with the prospect of a deal as it should boost British American’s flagging rate of growth. Lorillard and Reynolds reported a net profit of around £700m and £1.1bn respectively for 2013, so if British American acquired either, the company could see its net profit jump as much as 25%.

Possible headwinds

There are possible headwinds to a deal between these three tobacco giants. Lorillard and Reynolds in particular, specialize in menthol style cigarettes and would control around 50% of the US menthol market if a deal between the two went ahead. As a consequence, regulators are likely to demand that the companies divest some brands before merging. 

What’s more, according to insiders, talks between the three companies have broken down on several occasions, so there are obviously tensions in the board room. 

City expectations

So, there is the possibility that a deal between Reynolds, Lorillard and British American could struggle to get off the ground.

With this in mind, what does the City think about British America’s future?

Well, without a deal, City forecasts currently predict that the company’s earnings will continue their steady, predictable rate of growth for the next few years. However, as British American is currently trading at a forward P/E of 16.5, many investors may find the company expense.

Nevertheless, the company’s valuation is similar to that of is international peers. 

Foolish summary

Overall, if a deal between Reynolds and Lorillard goes ahead, British American’s shares will surge, as the company’s profits could jump by as much as 25%.

If there is no deal, the company’s shares are likely to continue rising, as slow steady earnings growth continues.

So all in all, I feel that British American’s shares will continue to rise. 

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In the meantime, please stay tuned for my next verdict.

Rupert does not own any share mentioned within this article.