E-Cigarettes Could Power Long Term Profits For Tobacco Stocks!

british american tobacco / imperial tobacco

On the face of it, now may not seem like a great time to invest in tobacco firms. That’s because cigarette volumes are falling, mainly due to increased counterfeiting, and tobacco companies such as British American Tobacco (LSE: BATS) (NYSE: BTI.US) and Imperial Tobacco (LSE: IMT) (NASDAQOTH: ITYBY.US) are having to continually raise prices in order to deliver top-line growth.

However, the tobacco industry could be on the cusp of significantly higher profitability due to the sudden emergence of e-cigarettes. They don’t contain tobacco and are smokeless, thereby reducing health risks, but they satisfy smokers’ cravings by delivering nicotine in a vapour. Both Imperial and British American Tobacco are well-placed to benefit from what is already a $1 billion industry — here’s why now could be a great time to buy shares in them.

British American Tobacco

As well as increasing prices, British American Tobacco is currently driving through substantial efficiency and productivity improvements to its business. The net effect of this is forecast earnings per share (EPS) growth of 9% next year, while British American Tobacco remains well-positioned to tap into the e-cigarette market via its Vype brand of e-cigarettes.

In addition, its shares currently offer a yield of 4.2%, with dividends per share having an extremely strong track record of growth and being forecast to increase by over 7% next year. Although British American Tobacco’s shares trade on a price to earnings (P/E) ratio of 16.2 — which is at a premium to the FTSE 100’s P/E of 13.9 — their potent mix of income and growth potential makes them attractive at current levels.

Imperial Tobacco

Until 2014, there was a concern that Imperial could be left behind its big tobacco peers in the race to dominate e-cigarettes. However, a deal to sell its Puritane e-cigarette brand in Boots earlier this year seemed to improve sentiment, with shares in Imperial now up over 12% year-to-date (versus a flat performance from the FTSE 100).

Despite this, they still offer good value and trade on a P/E of just 12.7, which is well below the FTSE 100 P/E of 13.9, and remain highly attractive for income-seeking investors, since they currently yield 4.9%. As with British American Tobacco, dividend growth remains strong, with dividends per share forecast to increase by 9% next year. This, combined with a great valuation and the vast potential from e-cigarettes, makes Imperial a strong long-term play.

Of course, tobacco stocks aren’t the only place that looks ripe for investment right now. That’s why The Motley Fool has put together a free and without obligation report on where we think the smart money is headed in 2014.

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Peter does not own shares in British American Tobacco or Imperial Tobacco.