Think the tobacco market is heading towards an ignominious end as people increasingly act sensibly and give up the weed?
Think again. While tobacco volumes might be falling slowly, there’s still plenty of years of profit left for British American Tobacco (LSE: BATS) (NYSE: BTI.US).
Here are three things that I think make the company a Buy right now:
1. Rising Margins
In 2013, the number of cigarettes sold by British American Tobacco fell by 2.7% to 676 billion, with total tobacco volume down 2.6%. And that continues a trend — a year previously the firm reported a 1.6% fall in volumes. But 2012 and 2013 each generated a 5% rise in earnings per share (EPS), because the company’s product mix is changing.
Rather than relying on volume increases from its lowest-margin products in poorer parts of the world, British American has been focusing its efforts on selling more of its premium brands. And it’s been succeeding. And while volumes are slowing, margins and overall profits have been rising. There’s a small dip in EPS forecast for this year, but analysts are back to an 8% rise for 2015.
2. Developing markets
Smoking might be frowned on in a lot of Western countries, and plain-wrapper and shock packaging do seem to be getting consumption down. But it’s a mistake to think that’s echoed across the whole of the developing world, and that’s where the future of up-selling to more prestigious brands is to be found.
British American’s biggest market in 2013 was the Asia Pacific region, which accounted for 30% of profits. Western Europe only brought in 21% of profits, and the Americas (which includes the growth markets of South America, including high-growth countries like Brazil), claimed 24%.
3. Throwing off cash
I recently wrote about British American Tobacco dividends and, to sum it up, what we’re looking at is a company paying yields of better than 4% which are well covered by earnings, and lifting the amount of cash handed out year after year.
In fact, the company has so much spare cash on its books even after handing out those generous dividends, it’s been using some to buy back shares — in 2014 it repurchased 44 million shares worth £1.5bn. So future profits will be spread over fewer shares.
That all makes British American Tobacco shares, on a forward P/E of 15 for 2015, look like an attractive long-term proposition.