Why British American Tobacco plc Should Beat The FTSE 100 This Year

smokingIf you’d taken a look at the British American Tobacco (LSE: BATS) (NYSE: BTI.US) shares early this year, you could have been forgiven for thinking the writing was on the wall for the tobacco business. By 6 February the price was down to 2,880p, an 11% drop from 3,238p at the end of 2013.

But since then it has bounced back to 3,642p for a gain of 12.5% so far this year — and there looks to be little chance of the FTSE 100 catching up before the end of December.

That follows a very strong trend — over five years British American is up over 80% and over ten it has more than four-bagged! Not bad for a company that many will see as a safe long-term dividend payer, with solid yields of more than 4% and rising every year.

Changing marketing

How has this been possible when tobacco volumes are falling year on year?

In 2013, cigarette volume fell by 2.7% to 676 billion with overall tobacco volume down 2.6%. But the key is what the company calls its “Global Drive Brands” — higher-margin upmarket brands which are being marketed to a growing affluent worldwide audience. At the time, chairman Richard Burrows said that “The Group’s Global Drive Brands also achieved outstanding growth in market share and volume” — volume was up 1.9%, with international brands up an overall 2.1%.

The trends were continuing at half time this year as total cigarette volume fell 0.4% but Global Drive Brands grew 5.7%, with chief executive Nicandro Durante predicting “another good set of results in 2014“.

Same again next year?

The question is whether the FTSE-busting years can continue.

I seriously doubt that the next five and ten years will see the same massive gains as in the past, not with the world increasingly turning away from the stuff and with the rise in total consumption which characterised the early years of the current century having reversed and gone into decline.

And with British American shares now on a forward P/E of 17, dropping to 16 for 2015 forecasts, they’re looking fully valued to me at the moment.

But I do still see a good investment here and a good chance of market-beating performance for some time yet. There are increasing millions of people getting wealthier every year and becoming more brand aware, and there’s a lot of potential in switching those 600 billion plus cigarettes sold every year for higher-margin brands.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.