From an investment perspective, the tobacco sector has huge appeal. After all, it is one of the very few industries in the world where demand for its products is likely to remain robust even if prices increase at a brisk pace.
This means that even with the popularity of smoking coming under pressure as a result of increasing health consciousness, tighter regulations and increased smuggling, tobacco companies such as British American Tobacco (LSE: BATS) and Imperial Tobacco (LSE: IMT) are able to maintain high single-digit growth rates over the medium to long term.
Furthermore, both companies benefit from a lack of new entrants. In fact, there are only a handful of tobacco firms which dominate the world market and, with regulations being so tight, additional companies entering the industry are very unlikely. This means that the two companies (and their peers) are likely to benefit from relatively high margins moving forward, which gives their investors a high degree of confidence in sales and profit visibility.
Of course, the tobacco industry is changing. The increasing popularity of e-cigarettes is causing tobacco sales to come under increasing pressure and, while there are a number rivals within the e-cigarette space, they are gradually being bought up by the major tobacco companies.
For example, Imperial Tobacco has acquired the blu e-cigarette brand and, while British American Tobacco has developed its own, internal brand called Vype, both companies have such strong cash flow that they could borrow to buy other e-cigarette firms over the medium to long term. Therefore, it seems likely that if e-cigarettes continue to gain in popularity, the likes of British American Tobacco and Imperial Tobacco will benefit from it.
Looking back at the two companies’ track records, they have offered sound growth numbers in recent years. In the case of British American Tobacco its net profit has risen at an annualised rate of 6.2% during the last five years, while for Imperial Tobacco the figure is 3.5%. Looking ahead, the former is due to increase its bottom line by 7% next year, while the latter’s earnings are forecast to rise by 10% in the current year.
With the two companies trading on price to earnings (P/E) ratios of 18.6 and 15, they appear to offer excellent value for money compared to other global consumer goods companies; none of which offer the stability or reliability that the tobacco companies provide. Therefore, upward reratings could be on the cards – especially if the market’s recent downturn continues and investors decide to flock to relatively safe assets.
Meanwhile, both British American Tobacco and Imperial Tobacco have FTSE 100-beating yields. They yield 4% and 4.4% respectively, with dividend rises having easily outpaced inflation during the last five years and being set to continue to do so over the medium term.
Certainly, the effects of tobacco on smokers’ health is likely to dissuade a number of individuals from buying either company. While that is entirely understandable, from a purely investment-related standpoint both British American Tobacco and Imperial Tobacco appear to be among the best long term investments in the FTSE 350.
