Life isn't getting any easier for global tobacco companies. Sluggish demand in established markets for traditional tobacco products is weighing on growth at both Imperial Tobacco (IMT) and British American Tobacco (BATS). That has left them reliant on more volatile emerging markets for sales of their traditional cigarette brands.
In Europe and the US, the future for cigarette companies seems to lie with electronic products. Debate is still raging over the safety and efficacy of these products. The World Health Organisation (WHO) has warned that e-cigarettes could be just as harmful as traditional tobacco, particularly for passive bystanders. There's also conflicting evidence as to whether they're an effective tool for smokers looking to wean themselves off traditional tobacco or quit the habit altogether. Yet consumers seem to have cast their vote: with sales up roughly 40 per cent, e-cigarettes became the fastest-growing supermarket product in Britain last year.
The industry is in a state of flux for other reasons too. In July, two of the US tobacco giants announced their intention to merge. As part of the high-profile $27bn deal between Reynolds and Lorillard, Imperial will pay $7bn for the Winston, Salem, Kool and Maverick brands. In doing so, Imperial will push its share of the US market up to around 10 per cent, from roughly 3 per cent at present. Imperial's UK-based rival British American Tobacco - which had a 42 per cent holding in Reynolds - will inject $4.7bn into the newly enlarged company to maintain its stake.
Tobacco stocks are divisive by nature: what's good for a portfolio is not always good for your conscience. But for those investors looking for medium-term income, the vice industries are attractive: like their gambling cousins, tobacco companies entice investors with the prospect of generous dividends and special shareholder handouts. By way of illustration, Imperial upped its dividend by a tenth when it announced half-year results in November.
That income profile has earned tobacco groups some very respectable fans: fund manager Neil Woodford's recently-launched CF Woodford Equity Income fund boasts two tobacco stocks among its top three holdings. But these aren't stocks investors can leave in a drawer, collect the income, and forget about. Global jurisdictions vary widely on how e-cigarettes will be approved and regulated for proper use. And looking further ahead, the proliferation of such products will only undermine the tobacco giants' traditional markets even further.
| Name | Price (p) | Market Value (£m) | PE Ratio | Dividend yield (%) | 1-year performance (%) | Last IC view |
| British American Tobacco | 3,691 | 68,793 | 19.6 | 3.9 | 17.2 | Hold, 3,555p, 30 July 2014 |
| Imperial Tobacco | 3,006 | 28,770 | 14.8 | 4.3 | 31.6 | Buy, 2,755p, 6 November 2014 |
Favourites
If we had to decide between London's two listed tobacco stocks, we would favour Imperial Tobacco. For a start, the shares yield close to 5 per cent, even though they've risen by more than a third over the past year. Moreover, Imperial will pick up the Blu e-cigarette brand from the Lorillard-Reynolds deal, which should give it another competitive edge over BATS.
Outsiders
Shares in British American Tobacco (BATS) still offer an attractive income stream, but it's hard to see why they deserve their premium rating. BATS' shares trade on 16 times forward earnings, compared with 13 times for Imperial. That's despite the fact that trading is no easier for BATS than Imperial, and currency headwinds are distorting figures for both companies.
