Stock markets could face headwinds in the short term, as investors face increasing uncertainty. This week, we had news that inflation in February jumped to a four-year high of 2.3%, above the Bank of England’s 2% target. Next week, Theresa May will trigger Article 50 of the Lisbon treaty, formally beginning the process of the UK’s withdrawal from the EU.
With a bumpy road ahead, buying defensive shares with strong dividend prospects could be a shrewd move for investors.
A formidable market leader
Tobacco is arguably the most defensive industry of all, because demand for its products tends to be resilient whatever’s going on in the wider economy. Tobacco companies have considerable pricing power, enabling them to increase revenues and profits even at times when many other industries may be struggling.
British American Tobacco (LSE: BATS) is the biggest tobacco group in the FTSE 100 and also the most international in the world, operating in more countries than any other. Its scale and tremendous geographical diversification further enhance its defensive qualities.
These qualities make for modest daily volatility in the shares. The stock has a beta of 0.56, which indicates that its shares will tend to move by only 0.56% for every 1% move in the wider index. Moreover, in the last bear market, while the FTSE 100 plummeted 48% in less than 18 months, BAT’s shares suffered a dip of just 4%.
The company’s resilience through tough times has helped it deliver a tremendous long-term return for its shareholders. Over the last 10 years, the annualised return has been 15%, with a growing dividend representing a not insignificant component of the return.
I believe BAT will continue to deliver in the coming years, because it’s set to become the world’s biggest tobacco group, with the acquisition of the 57.8% of US firm Reynolds that it doesn’t currently own. I think a forward P/E of 18, with a 3.6% dividend yield (covered 1.5 times by forecast earnings), represents excellent value for a formidable market leader in one of the most defensive industries around.
Accelerating shareholder value
The food and household products of Unilever (LSE: ULVR) may not have the addictive qualities of BAT’s but the consumer loyalty inspired by such trusted brands as Hellmans and Domestos isn’t far short.
In other respects, too, Unilever has much in common with BAT. Size and geographical diversification are notable shared defensive characteristics. Unilever’s beta of 0.58 is only marginally higher than the tobacco giant’s and, like BAT, Unilever’s shares also performed relatively well in the last bear market, with a 21% decline compared with the Footsie’s 48%.
Unilever’s rejection of the recent $143bn bid from Warren Buffett-backed Kraft Heinz only emphasises how rare and valuable its stable of brands is in the eyes of the shrewdest investors. Furthermore, the offer from Kraft has served to focus Unilever’s directors on “options available to accelerate delivery of value for the benefit of our shareholders”.
Unilever has delivered an annualised return of more than 12% over the last 10 years and with management looking to accelerate delivery of value, I believe the shares are worth buying on a forward P/E of 23, with a 2.9% dividend yield (covered 1.5 times by earnings).