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Why Neil Woodford Is Still Backing Tobacco

british american tobacco / imperial tobaccoAce fund manager Neil Woodford has been a long-term supporter of tobacco companies. Such ‘boring’ investments were out of fashion in the dot-com era, but Woodford was vindicated when the bubble burst.

Such contrarian calls enabled Woodford, during his tenure of the Invesco Perpetual High Income Fund, to turn a £10,000 investment in 1988 into over £230,000 (with income reinvested) by the time he departed.

Still smoking

Will Woodford buy into tobacco companies for his new CF Woodford Equity Income Fund? Well, at the last reckoning, British American Tobacco (LSE: BATS) (NYSE: BTI.US) and Imperial Tobacco Group (LSE: IMT) (NASDAQOTH: ITYBY.US) were meaty 8.2% and 6.7% holdings in a portfolio he still runs for wealth manager St. James’s Place.

Furthermore, Woodford has been singing the praises of tobacco firms during a recent two-week roadshow ahead of the launch of his new fund.

What Investment quoted him on why he’s continued to invest in tobacco over two decades:

“Tobacco has been undervalued for 20 years, and I have held it and made money from it for 20 years. People used to say to me, you are mad, tobacco companies are getting sued, they will go bankrupt. I said, they will just sell more in emerging markets. Then people said you are mad, the government are putting the taxes on tobacco up, and I said, well the tobacco companies will put the prices up in emerging markets”.

It’s well known that the industry is struggling to grow volumes, but Woodford is evidently convinced the companies can continue to grow earnings and dividends. Indeed, despite increasing regulation — plain packaging and so on — he reckons “tobacco companies are still very cheap”.

I can tell you that Woodford was still increasing his holdings in British American Tobacco and Imperial Tobacco up until the announcement of his departure from Invesco last October.

In the six months to 30 September 2013, he invested a further £78m in British American and £59m in Imperial for his Invesco Income Fund.

According to my calculations he paid 3,511p a share for his British American shares (at a trailing P/E of less than 17) and 2,262p a share in the case of Imperial (at a trailing P/E of less than 12).

At the time of writing, British American’s shares are trading at 3,600p, and on a similar P/E. Imperial’s shares have re-rated upwards (helped by takeover rumours) to 2,700p; but the P/E is, nevertheless, under 13, which compares favourably with the FTSE 100 average of over 14.

The Footsie’s two tobacco firms, then, are not valued too much differently to when Woodford was making multi-million-pound buys last summer. So, there would appear to be every chance he will be willing to buy them for his new fund at their current levels.

Beware the bull trap

The bull market, which has floated most boats, is now mature at five years old, and Woodford reckons picking winners is becoming more challenging.

It's a view shared by the Motley Fool's crack team of analysts. Indeed, our analysts believe only a handful of companies will make really big gains over the next 12 months.

As investors rush into a dangerous 'bull trap', you can discover What The Smart Money Is Buying In 2014 in a FREE wealth report we've just published.

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G A Chester does not own any shares mentioned in this article.