In this article let's take a look at an option for investing in the tobacco sector with British American Tobacco plc (BTI), which sells tobacco products in 180 countries. The company holds leadership positions in around 50 of them. Brands like Dunhill, Kent, Pall Mall, and Lucky Strike account for one third of group sales because they are well known and have been gaining share over the past several years.
Two remarkable points for the company are its strong brand loyalty and cost advantages. The firm focuses on product innovation and cost reduction, while we know both things might be difficult to achieve at the same time.
The tobacco sub-industry is extremely competitive but consumer´s loyalty is a very important characteristic. Although in times of recessions some consumers switch to cheaper brands, the company focuses on innovation. The launching of line extensions at a price premium to the heritage brand, increase complexity and costs, is a less risky strategy than competing on price.
Top Global Cigarette and Cigar Manufacturers by Revenue
British American Tobacco plc
Imperial Tobacco Group plc
Reynolds American Inc.
Cash to Investors
A company characteristic is that demonstrate its commitment to return cash to investor in the form of dividends. The current dividend yield is about 4%, which is considered very good to protect the purchasing power. The company will continue to pay out two thirds of its adjusted net income as dividends.
Return on Equity
Let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
British American Tobacco
Reynolds American Inc
In terms of valuation, the stock sells at a trailing P/E of 17.4x, trading at a discount compared to an average of 19.5x for the industry. To use another metric, its price-to-book ratio of 9.7x indicates a discount versus the industry average of 10x while the price-to-sales ratio of 4.38x is above the industry average of 3.85x. The first two metrics indicate that the stock is relatively undervalued and seems to be an attractive investment relative to its peers, because at that ratios it seems cheaper compared to the industry average.
As we can see in the next chart, the stock price has an interesting upward trend in the five-year period. The EPS are included because it often leads the stock price movement.
This industry faces strict anti-smoking regulation, taxation and high barriers to entry, make it attractive for well-known brands. Further, the tobacco portfolio and e-cigarettes gives the firm economies of scope and scale that make it difficult for new entrants to compete.
Despite the industry has strong competition, the business is relatively stable; government intervention is an omnipresent threat and litigation risk is lower for the European players, so I would recommend fundamental investors to consider this attractive option for their long-term portfolios.
Hedge fund gurus like Sarah Ketteter, Tom Russo (Trades, Portfolio) and John Rogers (Trades, Portfolio) added this stock to their portfolios, and I would advise fundamental investors should consider adding this stock to their long-term portfolios.
Disclosure: Omar Venerio holds no position in any stocks mentioned