The senior executives of the two UK-listed tobacco giants sounded confident when announcing their results at the end of last year. They appear to believe that the addictive nature of their product insulates them from deteriorating economic conditions. Indeed, British American Tobacco's (BAT) chief executive, Paul Adams, remarked: "2008 is shaping up to be a vintage year for BAT.”
BAT's UK competitor, Imperial Tobacco, talked a good game, too. The group's chief executive, Gareth Davis, effectively tackled questions over the refinancing of the company’s massive debt position - a legacy of its £11bn acquisition this time last year of Franco-Spanish tobacco company, Altadis. As at 30 September its net debt stood at a whopping £11.7bn. “We’re comfortable with the financing situation,” insisted Mr Davis.
But despite the confident tone coming from the sector's top bosses, it is possible to detect a whiff of complacency emanating from the big smoking empires. After all, 2009 will see consumers around the world tightening their belts - or at least trading down - as the recession bites. And the industry's markets in developed countries - which are already either flat or declining - face many threats from the health conscious anti-smoking lobby. Indeed, a recent initiative on that front could even see cigarettes removed from sale from behind supermarket counters.
One saving grace for the tobacco companies has been their growing sales from emerging markets where, so far, there has been little evidence of trading down to the cheaper value brands. Indeed, just over half of BAT’s operating income comes from emerging markets, with important contributors being South Africa (14 per cent), Brazil (9 per cent), Russia (3 per cent), Mexico (3 per cent) and Venezuela (3 per cent). The group has a history of squeezing increased returns from these regions, although there is always the possibility that its customers could switch to cheaper brands as discretionary income falls.
Imperial Tobacco’s exposure to emerging markets has climbed following the acquisition of Altadis. Previously about 10 per cent of operating profits came from emerging markets, but this is now closer to 30 per cent. Almost half Altadis’ sales by volumes are made to countries such as Russia, Morocco, Poland and the Middle East.
Despite some clearly defensive characteristics, however, share price ratings for the pair - at between 14 and 15 times - are hardly cheap, and suggest that any good news is already priced in. That said, the precarious debt position at Imperial suggests that investors would do better to stay focused on BAT.
Summary of sector:
| Company | Price p | Mkt. value £m | PE ratio | Yield % | 12-Month price chng % | Last IC view |
|---|---|---|---|---|---|---|
| BRITISH AMERICAN TOBACCO | 1865 | 37227 | 15.1 | 3.7 | -4.4 | |
| IMPERIAL TOBACCO GP. | 1899 | 19298 | 13.9 | 3.5 | -18.2 |
