Is It Time To Buy British American Tobacco plc?

While the FTSE 100 has underperformed so far this year, British American Tobacco (LSE: BATS) (NYSE: BTI.US) has had a good year to date. Its share price has risen over 14 percent, while the FTSE 100 has declined by close to 1.5 percent, as of the time of writing.

This increase has made BATS expensive relative to the FTSE 100, with respect to its PE ratio. It currently has a PE ratio of about 18 compared to FTSE 100’s 14. However, despite being more expensive, it still offers some growth potentials for the long-term investor. Here are some areas to consider.

Global Drive Brands keep rising

Between 2009 and 2013, BATS’ volume dropped by about 6.6%. And it is likely that the trend will continue this year given that volume for the first nine months of 2014 declined by about 1.5 percent compared to the same period in 2013.

However, volume and market share in its Global Drive Brands have been growing impressively during the years in which total volume has been declining. The increase here is driven by entrance into new markets. For instance, Pall Mall has grown into more than 100 markets as of 2013 compared to 60+ in 2007. In addition, the company has added Rothmans to the group this year. This is helping the company grow its revenues amidst dropping volume. Indeed, the growth in this segment is bound to continue considering that the segment saw a 6.2 percent increase in volume for the first nine months of 2014 compared to the same period a year ago.

More profitable compared leading tobacco companies

While BATS is behind Philip Morris in terms of global market share, BATS has managed to be more profitable. It’s also more profitable than Imperial Tobacco Group and Japan Tobacco. For instance, it currently has a gross margin of 78.13 percent for the trailing 12-month period compared to 65.72 percent, 59.30 percent and 19.8 percent by Philip Morris, Japan Tobacco and Imperial Tobacco respectively, for the same period. And more impressively, there has been no time over the last four years that any of these competitors has managed a better gross margin than BATS.

This is driven by the fact that BATS focuses its marketing effort mostly on its Global Drive Brands. If the company continues with this model, it is likely that it will remain profitable going into the future.

Growth in emerging markets

With cigarette consumption dropping in Western Europe and the Americas, BATS has been shifting its focus to the emerging markets, especially Asia-Pacific. For instance, according to a Morningstar analyst, BATS gets about 82 percent of its volume and about 58 percent of its revenue from emerging markets. Indeed, the growth opportunity in these markets is huge. Here is why. As economy in these markets becomes better, consumers would have more disposable income to spend on things like cigarette. And in the end, a company with strong presence in such region, like BATS, stands to benefit immensely.

Being cautious

Truth be told, while the points I have discussed offer hope that BATS share price could rise over the long term, its high PE ratio, which is, by the way, higher than those of its mentioned competitors, suggests that there is not much room growth in theory. So investors with low risk appetite may rightly want to look somewhere else.

If that's you, I strongly recommend that you read a new information-packed free report from the Motley Fool. It discusses five companies with perhaps better valuation than BATS that are good enough to retire on.

As a bonus, you will also know some of the most important valuation metrics that can help you determine how good a stock is for the long term. The report is absolutely free and with no further obligation. Click here to get it.

Craig Adeyanju 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.