Income play British American Tobacco in poor health

Among the FTSE 100 stocks on the back foot so far in 2018, one of the most notable casualties has been British American Tobacco.

This attractive dividend payer is now trading at levels last seen in early 2016, with today's in-line half-year update doing little to ignite buying interest.

The question for investors will be whether the current depressed price now represents a good time to return, or should they bear in mind the approach of fund manager Neil Woodford who sold his BAT holdings last year? 

Shares have been on a downward path ever since last summer's completion of BAT's transformational deal to buy the remainder of America's Reynolds - a purchase that created the world’s biggest tobacco company.

The tie-up is supposed to speed up BAT's development of e-cigarettes and vapes as well as create a more balanced presence in high growth emerging markets and higher profitability developed markets.

For shareholders, BAT said increased access to group cash flows should provide further support to the company's commitment to a dividend payout ratio of at least 65% of earnings. BAT's proud record of dividend growth is one of the best in the FTSE 100 Index, stretching back as far as 1999. 

It's too early to judge the success or otherwise of the Reynolds acquisition but it’s fair to say that BAT and other defensive stocks haven't been helped by external factors.

The prospect of rising interest rates has lessened the appeal of income stocks such as BAT, while the recent improvement in sterling has impacted the company now that more of its revenues come from the United States.

This was highlighted today when the company said EPS growth is expected to be knocked by a significant currency translation headwind of around 9% for the first half and 6% for the full year.

At constant exchange rates, BAT said it remains on track for "another good year" of earnings growth, helped by the benefit of US tax reform and significant increased investment in Next Generation Products (NGP).

While the overall cigarette market has been in decline, BAT believes it can generate £1 billion in revenues from NGPs, which include vapour and tobacco heating products, as well as oral tobacco and nicotine. By 2022, it hopes to have increased this figure to more than £5 billion.

Whether this will be enough to tempt back investors remains to be seen, even with a dividend yield in the region of 5%.

BAT featured in both Woodford's CF Woodford Equity and Income Focus from their inception, having been a staple part of his mandates for 20 years.

But Woodford’s team pointed out last year that at the peak of the dotcom bubble in March 2000 you could have bought BAT for only 225p, whereas the fund manager was able to sell up at 5,000p on the belief that the valuation opportunity in the sector has "largely played out".

Source: interactive investor      Past performance is not a guide to future performance

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.