A cheap stock to beat the slump
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Associate Editor
David Stevenson May 07, 2009
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BAT - another year of good earnings
The economy is in the grip of potentially the worst recession in living memory, but some things just don't change. Regardless of boom or bust, bubble or slump, people just keep on smoking.
Cigarettes are bad for your health, but if you're a shareholder in British American Tobacco (LSE:BATS), they've certainly not been bad for your wallet.
And there's no sign that this will change any time soon, recession or no...
In these troubled times, perhaps people who've 'given up' cigarettes are finding that a quiet smoke is just what they need to calm their nerves. Because stock market crashes and property busts certainly don't seem to have dimmed the appeal of a visit to the tobacconist counter.
Yes, as British American Tobacco admitted yesterday, there's been some 'trading down', with smokers plumping for cheaper brands and leaving their more expensive cousins on the shelf. What's more, there was some comment from Europe's largest cigarette maker that trading had become a bit tougher, while smuggling – another sign of the recession, as people try to evade taxes and get their cigarettes more cheaply - is on the rise.
BAT looks set for another year of good earnings
Yet despite those slight hiccoughs, BAT was still remarkably upbeat. And why not? First quarter sales volumes were up 7% on last year, a big chunk of debt was repaid and there's "another year of good earnings growth" in the pipeline.
Net result: happy shareholders, as the stock flipped up nearly 4% on the day. In other words, just about business as usual.
BAT's consistency is actually pretty surprising when you think about it. Here's a company that many thought would be legislated out of existence, or at the very least driven towards bankruptcy by US lawyers. And even if that didn't happen, life for cigarette makers was widely expected to get much tougher as anti-smoking campaigns hit home. Meanwhile governments have kept on hiking tobacco duty, which was supposed to price cigarettes out of everyone's reach.
But it hasn't turned out that way. BAT has been fighting the likes of smoking bans for most of its 100+ year existence. And the company has quietly continued making good money, and churning out loads of cash as well.
And that's shown up in the share price. Over the last 10 years, BAT shareholders have more than trebled their money. What makes that all the more stunning is that if you'd simply left your capital in a FTSE 100 index tracker, you'd have lost a third of it over that time.
Below you can see a chart of the stock compared with the market over the last decade – BAT has outperformed the FTSE 100 by 350%.
Even over the last two years when shares have done particularly badly, as a BAT holder you'd still be well ahead of the game. This stock has outshone the indices by well over 50%.
Why BAT is an especially good buy now
And amazingly after all that out-performance, because of the business it's in, BAT is still cheap. It's on a current year PER (price to earnings ratio) of only 11 times, which is a lower rating than the overall market. Further, this falls to just 10.3 times in 2010. Even better, your prospective yield is near 6%.
That would look pretty good at almost any time. And it's particularly handy given that the current stock market rally feels like it's nearly run its course.
There's still plenty more economic bad news on the cards. As we point out in the magazine this week (if you're not already a subscriber, get your first three issues free here), we may have been living through a financial crisis, but so far we've only seen the start of the huge damage that will be inflicted on the 'real' economy by long-term credit being cut back by lenders. The banks simply don't know how many more of the loans they so gleefully handed out in the boom will go bad in the bust. Or if they do have an inkling about the horrible truth, they're not telling the rest of us.
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And that means the UK could be in for several years of what economists euphemistically call 'sub-trend growth'. As Jonathan Loynes of Capital Economics put it yesterday, "a return to positive growth in the economy still appears a long way off".
In other words, it's going to get pretty nasty. Not good for share prices tied into British consumers. But not so much of a problem for BAT, which with 13% of the global tobacco market, generates less than 20% of its overall sales from Western Europe. And if the pound keeps sliding, firms like this which earn the vast majority of their revenues in foreign currencies can only benefit.
The classic defensive to beat the slump
BAT is the classic "boring defensive" share that more than matches the growth stocks. And although borrowings, built up by its ongoing acquisitions, are high - at almost £10bn, net debt was more than 40% higher than shareholders' funds at the end of 2008 - while the cash keeps flowing in, that's no problem. The company paid off €900m in this year's first quarter alone.
"BAT is my favourite company", says David Shapiro of Sasfin, who highlights the firm's growth in emerging markets and less developed countries. "It's a high cash generator and you get very good dividends. I think in this market it remains a very strong buy and should be in portfolios".
Just now the shares are 20% below their highs of January 2008. If you can live with the idea of buying into tobacco stocks, that pullback opens a window for BAT to be part of yours, too.
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