Tobacco does not appeal to many but there are sound financial reasons to buy in
BAT faces problems here and fresh headwinds in the US. Yet its strengths are being overlooked, says Russ Mould
THE nature of its product and a Serious Fraud Office investigation into allegations of bribery in Kenya mean that British American Tobacco is not a stock that will pass muster for investors who prefer to have an ethical bent to their portfolio – but the subsequent price swoon could present patient, long-term investors with a chance to step in.
The SFO’S work must not be taken in any way lightly, given that the 2010 Bribery Act can lead to swingeing fines, reputational damage and even loss of licence to operate. How BAT responds to the investigation, and how it plays out, are likely to influence near-term sentiment towards the stock.
Hard to believe as it may be, the SFO process may find itself overshadowed by an even bigger issue, namely the announcement right at the
end of July that the US Food & Drug Administration (FDA) is looking into how it can lower nicotine levels in cigarettes to what it calls “non-addictive” levels.
The FDA’S declaration hammered shares in BAT and those of its international peers, such as Altria (MO:NYSE), Philip Morris (PM:NYSE) and Imperial Brands (IMB), but this reaction could be overdone for four reasons.
First, the FDA is currently starting what it terms a public dialogue, but the regulator is offering no firm timeline for its consultation. Second, the American authorities do not define what they mean by “non-addictive” levels of nicotine. Third, hardline anti-tobacco campaigners may even be disappointed by the plan, which does not contemplate either a ban or heavier taxation. Finally, any major move on tobacco levels could prompt an accelerated shift to next-generation products (NGPS), where BAT has a very strong position via its Vype offering and now Vuse, a leader in the US vapour market, following July’s £41.7bn purchase of the 57.8pc stake in Reynolds American it did not already own.
The move to 100pc ownership of Reynolds, which deepens BAT’S presence in the US, may therefore not be as unfortunately timed as the share price response to the FDA’S consultation suggests.
BAT is targeting $400m (£307m) of cost synergies from the acquisition and this helps to underpin analysts’ forecasts for further steady earnings and dividend growth, despite the
long-term challenges posed to cigarette volumes by regulatory action and public health campaigns.
Industry consolidation via takeovers, cost reduction and the development of NGPS are three prongs of a four-point strategy to tackle such threats.
The fourth is continued investment in brands, which can still drive demand and particularly price increases for their products.
The gradual shift to plain packaging in certain countries, including Australia, France, Britain and Ireland, is a further threat here, but emerging markets remain a key focus, with 80pc of smokers living in low and middle-income countries, according to the World Health Organisation. It is growth here that is helping compensate for declines in the West.
Questor says: buy Ticker: BATS Closing price: £50.55
UPDATE: Clipper Logistics
Shares in Clipper Logistics slipped a little even as the Yorkshire firm published excellent full-year results at the end of last month (July 28), and this column is going to take the hint by taking profits on a stock that has risen by more than 20pc since our first look at it last October.
The company handles warehouses and delivery services for retailers, including Asda, Asos and Tesco. Revenues rose 17pc to £290m and profit after tax jumped 21pc to £12.5m.
The only real issue investors need to address is that of valuation. The £12.5m net profit compares to a market capitalisation of £417m, so that puts Clipper on a historic price-toearnings ratio of 33.3 times.
Even the 20pc to 30pc growth in earnings pencilled in by analysts for the years to April 2018 and 2019 leaves the stock on forward multiples of 26 times and 21 times, a big premium to the wider UK market and sector peers. That prices in much good news. Questor says: some investors might like to wait for the 7.2p interim dividend but the full valuation suggests it is time to take profits Ticker: CLG
Closing price: 421p