The Best Reason To Buy British American Tobacco plc

smokingTobacco is nasty stuff and smoking is being increasingly seen as unacceptable in some societies, so why would you consider buying British American Tobacco (LSE: BATS) (NYSE: BTI.US) today?

If you’d bought 10 years ago, your investment would have multiplied 3.5 fold to a share price of 3,606p today — and that’s without considering the company’s substantial dividends.

That was the past

But tobacco volumes are falling. In 2013, British American reported a 2.7% fall in the number of cigarettes sold, to 676 billion — and by half-time this year, volumes were down another 0.4%.

Earnings per share (EPS) growth has been slowing, and there’s actually a 3% fall forecast for 2014. But that’s followed by a 9% rise penciled in for 2015, and analysts putting out Buy recommendations outnumber the Sells by four to one. What’s happening?

New direction

British American is changing its strategy. Instead of targeting simple volume growth, which includes a lot of low-margin sales in poorer parts of the world, the company is shifting its marketing efforts to its Global Drive Brands — more prestigious brands which command significantly higher margins.

And it’s paying off.

Although overall volumes fell in 2013, Global Drive volumes rose by 1.9% with International brands up 2.1% overall. And at 2014 interim time, we heard of an impressive 5.7% gain in Global Drive sales.

Same again next year?

Dividends have always played a key part, and British American has been yielding more than 4% over the past five years — and analysts are forecasting yields of 4% and 4.4% for this year and next. That’s better than the FTSE 100 average, and helps justify a 2015 forward P/E of 16.

The dividends have always been adequately covered at a little over 1.5 times. And although that would dip to 1.45 times on 2014 forecasts, predictions for 2015 would see cover starting to strengthen again.

That takes us back to this Global Drive thing again, and I reckon the change in focus with that early success is the best reason not to write off British American Tobacco now but instead to see it as a company with renewed opportunities.

The new rich

It’s still selling more than six hundred billion cigarettes per year, and with the rising number of upwardly-mobile middle-class consumers in the world’s growing economies, upselling few more billion of those a year to higher-margin brands should keep those dividends rolling in for a good few years yet.

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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.