While delivering the Autumn statement, Jeremy Hunt recently announced that the UK was in a recession. This does not spell good news for British shares, which look likely to face a stock market correction.
However, some industries thrive during recessions. Tobacco is one that could provide me with an opportunity.
British American Tobacco (LSE: BATS) is one of the largest players in this market. I’ll now explain why I’d invest if I had the spare cash.
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Background
As the name suggests, British American Tobacco sells cigarettes. It owns popular brands such as Dunhill, Lucky Strike, and Vuse. With a market cap of £76bn, it is also one of the largest constituents of the FTSE 100.
While the Footsie as a whole has increased by less than 1% in 2022, British American Tobacco has gone up by over 23% in the same period.
It faces some challenges. Notably, in the UK, the proportion of adults who are regular smokers has fallen substantially from 27% to 16% between 1993 and 2019.
Furthermore, the underlying business is not immune to the cost pressures currently facing the economy. This is demonstrated as the latest quarterly earnings fell by a dramatic 42.8% year on year (YoY), even while revenue is growing.
However, I believe the positives for British American Tobacco greatly outweigh these drawbacks.
Recession-resistant
Firstly, smoking is a very addictive habit. This is why we see tobacco consumption remaining consistent during recessions. Consumers typically become conscious of their expenses during economic hardship, but tobacco isn’t one of them. British American Tobacco is therefore in a fortunate position where it shouldn’t face a demand problem.
Revenue growth
Secondly, even though profits are falling, quarterly revenue still increased by 5.7% YoY. This shows the fundamentals of the business are still intact. Once the economy settles and cost pressures ease, earnings should resume growth.
Cheap valuation
Furthermore, the valuation of shares looks very enticing. British American Tobacco currently sports a forward price-to-earnings (P/E) ratio of 8. This is almost half the average P/E ratio for a FTSE All-Share company of 14.
Great dividend yield
If you’ve read my two previous articles, you’ll notice I like stocks that offer passive income. British American Tobacco has an extremely attractive dividend yield of 6.4%. If I had the spare cash to invest, I could generate £1,000 annually in passive income by buying 456 shares at today’s share price of £34.27 each.
Now what
British American Tobacco undoubtedly faces issues with the number of smokers declining and retreating earnings. However, the true decline in the number of smokers isn’t as rapid as it first seems. When the population of each period is accounted for, smokers have only declined by 31%. The tobacco market has also raised prices sixfold since the early nineties. This explains why British American Tobacco has continued growing revenue over the years.
Combined with the fact that it is very cheap, is resistant to economic contraction, and has a strong dividend, I would buy shares of British American Tobacco if I had the spare cash.
