Interactive Investor

A FTSE 100 stock with 23% upside and 8% dividend yield

26th January 2022 15:19

Graeme Evans from interactive investor

Pro investors are backing this income stock to do well in 2022, and one of them has named it their top pick in its sector. Find out which one it is here.

A “best-in-class” dividend yield and shelter from inflationary pressures mean British American Tobacco (LSE:BATS) shares continue to attract attention after rising 16% so far this year.

Bank of America added to this interest today when it upgraded its price target on the FTSE 100-listed stock by 200p to 3,900p, representing a further possible upside of 23%.

After years of de-leveraging, it expects BAT to announce a buyback at next month's annual results and said there's the potential for this to total £7 billion over three years. If that's the case, it could mean a cumulative boost to earnings per share of 8.5%.

Bank of America regards BAT as its top pick in a food and tobacco sector that also includes the likes of Reckitt Benckiser (LSE:RKT), Diageo (LSE:DGE), Unilever (LSE:ULVR) and Nestle (SIX:NESN). It said its updated price target is also the reflection of improving organic revenues growth prospects.

It said: “Not only do we see strengthening fundamentals, but we also think BAT ticks all the boxes "top down" given protection from inflation (high gross margin/price in-elastic category) and best-in-class dividend yield of around 8% in the context of rising rates.”

The yield compares with 2.6% across the wider consumer staples sector and is only rivalled by fellow tobacco stock Imperial Brands (LSE:IMB).

BAT is best known for the tobacco brands Dunhill, Rothmans and Pall Mall, meaning that ethical issues continue to make the company and industry untouchable for many investors.

But BAT is making inroads in alternative products that are crucial for improving stock market sentiment, including vapour businesses Vuse and Vype and tobacco heating brand glo.

BAT added 3.6 million consumers of non-combustible products in the first nine months of the year, more than in all of 2020, as chief executive Jack Bowles continues to target £5 billion of revenues from new categories by 2025.

The bank sees the accelerated rollout of glo Hyper in Europe and North Africa as a particular turning point for BAT's new categories business. It believes the “heat not burn” sector has reached critical mass in terms of awareness and that there's the potential for BAT to see compound revenues growth in the region of over 60% in the period up to 2024.

“Meanwhile, BAT's relatively low market share in combustibles means that we expect cannibalisation to remain limited,” the bank added.

One potential concern is the potential for the US Food and Drug Administration (FDA) to press ahead with plans for a ban on menthol cigarettes.

Menthol represents around 37% of the US cigarettes market, with BAT being the biggest player with around 55% market share and its Newport brand accounting for the vast majority of the company's exposure.

But the bank believes any menthol ban is already reflected in the share price, even based on its own worst-case scenario for a 12% earnings hit.

BoA's analysts added: “Even if (and this is a big if) the FDA publishes a proposed rule in April, a potential ban (if any) would still be 2-3 years away in our opinion, and potentially much more.”

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Related Categories