It may not be an exciting tech stock, but the relatively boring business of selling cigarettes hasn’t stopped shares of British American Tobacco (LSE: BATS) acting like the hottest new Silicon Valley stock and rising over 200% in the past decade. And, even after this dramatic leap in share prices, I believe BAT’s non-cyclical revenue, wide moat to entry for competitors, solid growth potential and steady dividends still make it a great buy today.
Selling cigarettes is about as defensive an industry as you can find, and this is clear when we look at BAT’s steady sales performance even during the dark days of the Financial Crisis. In both 2008 and 2009 the group recorded double-digit revenue growth as smokers across the world kept reliably buying cigarettes. The ability to continue growing sales despite economic turbulence is a quality that investors shouldn’t ignore as it props up share prices throughout the business cycle.
Offsetting declines
Critically, consumers not only continue buying cigarettes during economic downturns, but also remain loyal to their chosen brand. This brand loyalty is a massive boon for BAT at it gives the company incredible pricing power and acts as a powerful moat to entry for competitors. Pricing power is important for BAT as it leads to high margins and offers the ability to counteract falling volume with higher prices. We see this in adjusted operating margins that topped 36% for the six months through June. And, since smokers don’t frequently switch brands, there is little fear of new competitors springing up to steal market share.
Tobacco use has, for good reason, been under attack from regulators for decades, leading many to write off the industry as one in a perpetual state of decline. And, it is true that smoking isn’t as popular in the developed world as it once was, but that doesn’t mean cigarette companies aren’t growing. BAT has found rising demand from increasingly wealthy emerging markets more than capable of offsetting the slow decline in volumes from developed economies. Indeed, in the first nine months of 2016 BAT’s total sales volume increased by a full 2% year-on-year, which is quite impressive for such a massive company.
Amazing margins
Investors have traditionally been attracted to cigarette companies for their dividend potential, and this is another area where BAT does not disappoint. Strong cash generation supports a steadily growing dividend that now yields a full 3.5%. There’s plenty of room for shareholder returns to continue growing in the years ahead as earnings cover dividend payouts a healthy 1.35 times over. And, City analysts are bullish that the next two years will bring double-digit earnings growth, which is enough for them to forecast a further 16% rise in dividends by 2017.
The defensive nature of its business, high growth potential, amazing margins and reliably rising dividends are more than enough for me to happily consider owning BAT shares despite their pricey 18x trailing earnings valuation.
