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Sugar vs Tobacco: Should You Buy Associated British Foods plc, Tate & Lyle PLC or British American Tobacco plc?

SugarIf I asked you to name a sin stock, you’d probably suggest British American Tobacco (LSE: BATS)).

You probably wouldn’t mention the UK’s sugar giants, Associated British Foods (LSE: ABF) (NASDAQOTH: ASBFY.US) and sweetener manufacturer Tate & Lyle (LSE: TATE).

Despite this, recent press coverage has suggested that both sugar and sweeteners could be linked to the west’s obesity and diabetes epidemic. This view isn’t yet universally accepted, but the evidence is mounting, and I believe investors need to consider the potential implications.

Tobacco 2, Sugar 0

Although sugar producers are never likely to face the kind of regulatory pressure under which tobacco firms trade, they do have a number of disadvantages, in my view:

Tobacco firms

Sugar producers

Consumers are intensely loyal to global brands, which drive premium pricing power and high profit margins.

Sugar and sweeteners are essentially commodities, the price of which can be driven down by excess supply.

Regulatory restrictions are well understood and managed by the industry. Scientific evidence against tobacco is mature and no longer controversial.

Potential for future regulation or dietary changes by consumers is completely unknown. Scientific evidence still mounting against sugar.

Having reluctantly accepted that tobacco is harmful, the growth of unregulated e-cigarettes is an example of how the tobacco industry is seeking to adapt to declining levels of smoking in Western countries.

BAT has recently gone a step further, backing a small British start-up firm that’s launching a medically approved nicotine inhaler, targeting “mature smokers” in western markets!

What about the financials?

Leaving the arguments aside, how do the numbers look? Are any of these firms a compelling buy in today’s market?

 

Associated British Foods

Tate & Lyle

British American Tobacco

2014 forecast P/E

25.7

14.8

16.9

2014 prospective yield

1.3%

3.9%

4.1%

Operating margin

8.0%

10.3%

38%

BAT’s incredible profit margins mean that it can afford to service a substantial debt pile and pay generous dividends to shareholders. With a P/E of nearly 17, BAT’s shares are fully valued, but this reflects the demand for income in today’s market.

In contrast, ABF looks plain expensive, with an uncomfortable forecast P/E of 25.7%, the lower profit margins of the three, and an unappealing 1.3% prospective yield.

Tate & Lyle is the cheapest of these three firms and offers a decent yield. However, weaker demand and pricing pressure on its key Sucralose product has triggered two profit warnings so far this year, and despite management’s reassurances, I’m not completely confident a third disappointment won’t be on the cards.

Today’s best buy?

In my view, ABF is simply too expensive, given its low yield and weak growth prospects.

Tate & Lyle looks a reasonable buy despite the risk of further profit weakness this year, but the strongest contender for income has to be British American Tobacco.

BAT’s high profit margins and low capital expenditure mean that it generates a lot of free cash flow, virtually all of which is returned to investors each year. I can’t see this changing in the near future.

A top buying tip

Over the last ten years, British American Tobacco has delivered an average total return of almost 19% per year -- more than double the 7.8% the FTSE 100 has delivered over the same period.

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Roland Head has no position in any 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.