British American Tobacco (LSE: BATS) and BT Group (LSE: BT) are both highly defensive companies that might be attractive buys for your ISA. But if you had to pick just one, which should you choose?
Trying to pick between these two dividend stalwarts isn’t easy. On paper, they both look to be perfect. Both companies have relatively defensive business models, predictable cash flows, and leading market positions. What’s more, both BT and British American have a policy of returning extra cash to investors and their dividend yields are attractive at 3.6% and 4.7% respectively.
However, even though these companies might look similar on paper, they’re very different in practice. For example, BT is the UK’s leading telecommunications company, with billions of pounds of telecoms infrastructure built up over decades. Meanwhile, British American sells cigarettes, a business that’s considered by many to be in terminal decline.
The pros and cons
BT’s presence in the UK’s telecoms market is arguably its greatest strength. It would be impossible for a competitor to arrive and challenge the firm’s dominance overnight and it would take decades to build and receive the necessary approvals for such a large national telecoms network. That said, BT does have its problems. Competitors are nibbling away at the business, forcing the company to spend more on advertising, and calls for the company to be broken up are growing stronger. Nonetheless, for the time being, BT looks to be one of the UK’s most defensive businesses.
British American on the other hand, dominates the tobacco markets it operates in, but changing consumer habits are weighing on sales. For the time being, the company has been able to improve margins by cutting costs and hiking prices, which seems to be working. However, the company’s recent deal to acquire the rest of Reynolds American that it doesn’t already own shows that management is running out of options for organic growth.
Weighing up valuation
Both BT and British American have their problems, but when it come down to valuation, there’s one clear winner: BT is the cheaper of the two. Shares in the company currently trade at a forward P/E of 11.6 and City analysts have pencilled in earnings per share growth of around 10% for the next two years.
Meanwhile, shares in British American currently trade at a forward P/E of 18.3. Where British American stands out is growth. For 2017 City analysts are expecting the firm to report earnings per share growth of 16%, following growth of 19% last year. For 2018 analysts are expecting earnings per share of 308p, that’s up from 2012’s figure of 103p per share. It’s hard to argue against these growth figures. While British American’s outlook might not be as clear as that of BT, the company’s growth record shouldn’t be ignored.
The bottom line
All-in-all, both BT and British American are attractive ISA investments, but based on British Amerian’s growth potential, I’d rather pick the tobacco producer than BT.