Yahoo Finance Questor: tobacco stocks are an ideal investment even if inflation wrecks the economy
Investors who run strict screens for ethical, social and governance standards will despair. Of the top 10 performers in the FTSE 100 index in 2022 at the time of writing, two are oil producers, three are miners, one is a weapons manufacturer and one a cigarette giant in the form of British American Tobacco.
The three exceptions are Standard Chartered bank, AstraZeneca and Pearson, the publisher.
But it is the tobacco company that continues catch this column’s eye, albeit in the knowledge that such a stock will be far from suitable for every portfolio builder’s tastes.
Even after this year’s 20pc-plus advance in its share price, and a gain of more than 40pc from lows in early 2019, BAT’s shares trade on barely 10 times forecast earnings and offer a yield of more than 6pc from a dividend that is so well covered by cash flow that the FTSE 100 stalwart is also running a £2bn share buyback programme this year.
That takes forecast total cash returns to £7bn for 2022 and BAT still looks capable of further reducing its debts, which are already down by some £10bn, or a fifth, from a peak in 2017.
As this column never tires of saying, less debt means less risk and less risk can mean a higher valuation multiple and therefore a higher share price, all other things being equal.
This is not to neglect the challenges that face the business, be they its withdrawal from Russia, which will knock around 3pc off group sales this year, or the ongoing pushback against smoking from regulators and health authorities alike.
It is still far from clear to what degree “next-generation” products such as vapour and heated tobacco products will, over the long term, compensate for a decline in cigarette volumes.
But in the short term BAT does offer investors one valuable attribute: “price inelasticity of demand”, or, in plain English, the ability to put up prices and get its customers to pay them. This makes the company’s business model better suited than many to an inflationary – or stagflationary – environment and the explanation for the shares’ good run in 2022 could just lie here.
Any investor who fears a sustained bout of inflation – or indeed stagflation – may therefore be inclined to look more towards “consumer staples” such as tobacco (and perhaps alcohol, too) rather than more “consumer discretionary” items, and in this respect BAT fits the bill – unless the investor runs those ESG screens, a test the company will fail.
BAT could yet keep puffing higher. Hold.
Questor says: hold
Ticker: BATS
Share price at close: £33.02
Update: Telecom Plus
One trap into which this column occasionally falls headlong, despite its best intentions, is to mistakenly conflate a solid business model with a safe stock. The result is often portfolio pain as the price, or valuation, paid to access the company’s profit and cash flow streams is too high and that skews the reward/risk balance in an undesirable direction.
Despite its admiration for multi-utility Telecom Plus, this column now faces this very dilemma. A capital gain of about 35pc since our initial study at £11.62 a share in December 2016, with dividends of another 294p a share on top, only adds to the stock’s lustre and a trading statement late last month did nothing to diminish our admiration.
Telecom Plus is well placed to help those unfortunate householders whose energy suppliers no longer trade and positive word of mouth from its partners will also help, particularly as those partners continue to grow in numbers. Strong customer additions bode well for the future, especially as a period of investment in the service proposition may be drawing to a close, a further boost to profits.
The issue of valuation refuses to go away, however. The stock trades on almost 30 times forecast earnings for the year to March 2023, based on analysts’ consensus. Any upgrades to forecasts could make that figure deceptive but as ratings go it looks very full and after missing the chance to lock in gains at Strix, IP Group and others it would be remiss to do so now.
Time to (reluctantly) take profits.
Questor says: sell
Ticker: TEP
Share price at close: £15.62
Russ Mould is investment director at AJ Bell, the stockbroker
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