Tobacco Stocks Still Smoking Hot

As British American Tobacco reports good results for the first half of 2013, we look at the future of one of the best yielding 'sin' stocks

Emma Wall 1 August, 2013 | 9:58AM
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Tobacco may carry a health warning - but it has helped to provide healthy returns for investors' portfolios.

Despite two significant industrial threats in the past 20 years, tobacco stocks continue to pay out inflation-busting dividends, and if BAT's (BATS) results are indicative of the sector as a whole, this looks set to continue. 

Many industry analysts have been quick to write off tobacco companies. When the medical profession first revealed the damage cigarettes do to users' health, it was predicted that the developed world would stub out on mass. 

But fast forward two decades later - cigarette packets first carried serious warnings in the UK in 1991 - and consumers are still lighting up. In fact, global revenue streams have grown in that time, as emerging market consumers adopt the 'Western' pastime. 

Morningstar analyst Thomas Mullarkey said that although cigarette volumes continue to shrink throughout most of BAT’s markets, the firm’s Global Drive Brands continue to perform well and maintain their pricing power. This pricing power helped to drive up the firm’s operating margin by 100 basis points to 38.9% and to increase the company’s first-half earnings per share by 8% to 109.1p.

He continued: "We continue to believe that the firm’s key brands - Dunhill, Kent, Lucky Strike, and Pall Mall - remain healthy and are key contributors to the firm’s wide economic moat. We anticipate that we will slightly increase our fair value estimate as we update our valuation models and believe that the firm’s stock is fairly priced."

Fund managers such as Colin Morton, of the Franklin UK Equity Income fund (rated Bronze) hold tobacco companies for their reliable yield. He said he was not concerned by the stocks' so-called 'sin' status.

“Every company in my fund pays a dividend – it’s got to earn the right to be there, and tobacco stocks have more than earned their place,” Mr Morton said earlier this year.

“Tobacco companies have very low amounts of debt and offer investors inflation protection, as every year the Government whacks the duty up and the companies put prices up.”

The latest challenge to the tobacco industry - electronic cigarettes - is actually proving to be another opportunity for profit. 

British American Tobacco rolled out its new Vype e-cig in the United Kingdom this year - the first kind of product diversification in almost a century.

Mr Mullarkey commented: "It appears that the firm is following Altria’s and Reynolds’ lead by rolling out the e-cig in a small manner.

"However, unlike Altria and Reynolds, which are focusing on building a retail presence in a single city, Vype will first only be available online. Over the coming quarters, we expect Vype to broaden its channel distribution."

British American’s chief executive Nicandro Durante estimates that in many European countries fewer than 1% of smokers use e-cigs, but in France and Germany 3% to 4% of smokers also "vape."

Morningstar analysts believe that the e-cigarette category will see more competition than the traditional tobacco category, and consequently believe that e-cigarette margins will be noticeably lower than cigarette margins.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Altria Group Inc47.73 USD1.38Rating
British American Tobacco PLC2,507.00 GBX1.01Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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