When I think of cigarette manufacturer British American Tobacco (LSE: BATS) (NYSE: BTI.US), two factors jump out at me as the firm’s greatest strengths and top the list of what makes the company attractive as an investment proposition.
1) Consumable products
A business trading in consumable products tends to make an attractive investment proposition. There’s nothing quite like the steady stream of cash generated from constant repeat purchasing to warm investors’ hearts. With tobacco products, customer loyalty and habitual buying is even more deeply entrenched than for other consumables. After all, the customers are addicted to the product to the last soul: there’s a strong compulsion to repurchase with predictable regularity, much more so than when a packet of soap powder runs out.
The consistent cash flow that tobacco companies like British American Tobacco enjoy makes it possible to plan with a reasonable degree of certainty and to reward investors regularly. In common with other cigarette producers, we see evidence of this in the high levels of debt the firm carries and in the progressive-dividend policy, which the firm supports with a share buy-back scheme.
2) Rising earnings per share.
BATS puts its cash flow to use by paying a generous dividend and pumping up that payout’s effect for investors by buying back its own shares. The record of earnings- and dividend-per-share figures is impressive:
| Year to December | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|---|
| Revenue (£m) | 12,122 | 14,208 | 14,883 | 15,399 | 15,190 | 15,260 |
| Net cash from operations (£m) | 3,539 | 3,878 | 4,490 | 4,566 | 4,427 | 4,436 |
| Adjusted earnings per share | 129.6p | 153.8p | 176.7p | 195.8p | 208.6p | 217.4p |
| Dividend per share | 83.7p | 99.5p | 114.2p | 126.5p | 134.9p | 142.4p |
Right now, the forward dividend yield is running at about 4.6% with forward earnings covering the payout around one-and-a-half times. However, it’s worth noting that industry volumes are in long-term decline, which reflects in BATS stagnant revenue and cash flow figures.
What now?
British American Tobacco’s dividend looks attractive, but the firm’s flat-looking business makes me nervous. So what should I look for to pin down a solid dividend-grower with potential to deliver on total investor returns?