Major tobacco manufacturers like FTSE 100-quoted British American Tobacco (LSE:BATS) used to be highly sought after shares in tough times like these.
Not only are their products highly addictive — their megabrands command significant customer loyalty, meaning demand remains strong during good times and bad. BATS’ own labels include Pall Mall, Rothmans, and Lucky Strike.
So why does the company’s share value continue to sink? During the past 12 months, British American Tobacco’s share price has retreated 27%.
Cheap on paper
Unless you’ve been living in a cave, you’ll be aware that smoking as an activity is in serious jeopardy. You may see this in financial reports across the tobacco industry. Or you might have just observed a steady decline in the number of people you see in the street, outside work or the pub, or even on the TV.
The question I have to ask is whether the danger to British American Tobacco is reflected in the low cost of the company’s shares. On paper it certainly seems as if the company is going pretty cheaply.
At £24.85 per share, the company trades on a forward price-to-earnings (P/E) ratio of 6.5 times. This is well below the corresponding average of around 14 times for FTSE 100 shares.
A quick glance at the firm’s dividend forecasts also indicates solid value on paper. A prospective yield of 9.6% beats the FTSE index average of 3.7% by quite a margin.
Mounting pressure
Like billionaire investor Warren Buffett, I do love to pick up blue-chip bargains at knock-down prices. But I have no intention of buying British American Tobacco shares.
Declining cigarette usage isn’t the only reason why I’m avoiding the company. Lawmakers are also putting non-combustible tobacco products like vapourisers in the crosshairs amid mounting concerns over their soaring use.
Products like Vuse vape technology were once touted as the future of the industry. Not only were they marketed as safer ways for people to get their tobacco fix, they were viewed as ways to get users of cigarettes to kick the habit.
These products may still have a bright future. But a raft of unfavourable medical studies — combined with rocketing demand for these technologies among young people — suggest otherwise. Indeed, tight restrictions over their sale, use, and advertising are increasing across the globe.
As things stand, it’s difficult to see how British American Tobacco will generate earnings in this deteriorating trading landscape. Currently, only its Velo nicotine gum is avoiding mass scrutiny. And last year this generated revenues of just £240m in the first half of 2023.
Too much risk
The spectre of sinking revenues is especially concerning given the vast debts the company has. Adjusted net debt stood at a colossal £37.3bn as of June. This could have significant ramifications on the dividend sooner than many expect.
I believe the risks of owning British American Tobacco shares far outweigh any potential rewards. So I’d rather buy other cheap FTSE 100 shares following recent market volatility.
