The so-called ‘land of opportunity’ is becoming just that once again for tobacco companies. By the late 20th century, the US had become a market where smoking-related litigation proliferated and, as such, cigarette makers tried to keep a low profile. But this is changing, as demonstrated by the recent moves of the UK’s two listed tobacco groups: British American Tobacco (BATS) and Imperial Brands (IMB).
BAT already owns 42 per cent of Reynolds American (US:RA) and has made a recommended offer for the rest of the company. Imperial recently acquired brands from American company Lorillard (US:LO), which that company had to dispose of after Reynolds purchased it.
Why the desire to get back into the US? Well, it is the world’s second-largest tobacco market, behind China, but perhaps more importantly it is the world’s largest e-vapour market. This technology is something more smokers in developed markets are turning to and so the tobacco companies want to position themselves early. Any positive developments on this front during 2017 should be closely watched.
If BAT does secure the rest of Reynolds, it would become the world’s largest tobacco company by sales. We think this would make Imperial a prime target for an international rival and we have recently tipped the stock on that very basis. Even if it doesn’t get taken over right away, we’re bullish on the stock due to its decision to invest in expansion. This will suppress the growth in earnings per share for a year, but management has stuck its neck out and said it remained committed to the 10 per cent annual growth in dividend regardless of the upcoming £300m investment programme. The company’s forward dividend yield is the highest of its global peers, meaning investors are being paid to wait for the more usual (and higher) level of earnings growth to come through.
Companies in this space might have had to endure yet another attack on them in 2016 – this time in the form of plain packaging – but the sector boasts an enviable record when it comes to shareholder payouts and this doesn’t look as though it will be immediately interrupted. While there is talk of a rotation out of ‘bond proxy’ stocks, we think investment-grade corporate bond yields have a long way to rise before they rival tobacco stocks for income.
The potential cloud for tobacco stocks in 2017 could be emerging markets, though. With rising interest rates in the western world, some hot money could flow out of emerging markets and potentially dent local economies.
| Price (p) | Market value (£m) | PE | Yield (%) | 1-year change (%) | Last IC view | |
| British American Tobacco | 4,634 | 86,395 | 21.1 | 3.4 | 28.3 | Hold, 4,706p, 17 Jan 2017 |
| Imperial Brands | 3,569 | 34,216 | 54 | 4.4 | 0.0 | Buy, 3,474p, 5 Jan 2017 |
Favourites: We’re most keen on Imperial Brands as its investment plan seems sensible and doesn’t hamper investor payouts. On the all-important matter of dividends, a recent research note from broker IHS Markit said both Imperial and BAT were “expected to deliver double-digit increases on the back of positive earnings growth, assisted by favourable exchange rates”.
Outsiders: British American Tobacco isn't a bad stock but it yields less than Imperial. There's also the concerns about its mammoth debt load if it secures the deal with Reynolds it is pursuing.
