An Addictive Yield from Cigarettes 

07/15/2009 12:01 am EST


Douglas Moffitt

Editor-in-Chief, Successful Personal Investing

British American Tobacco boasts a spotless record of rewarding shareholders, writes Douglas Moffitt in The IRS Report.

I am still not convinced the March FTSE low will not be tested again, though I think it is increasingly likely it will not: the real test may not come until interest and inflation rates start rising again. But Sainsbury’s (LSE: SBRY) surprise equity cash raising was another wake-up call to remind us that, until the banks start lending properly again, it is likely to be shareholders—existing or newly-recruited—who will have to put up the working capital which companies need.

So, I will not be surprised if [other companies I invest in] come round to me with the begging bowl. I hope, on the basis of the big discounts at which other rights issues are being priced, that they will offer me better terms than I can get by buying in the market now. And if the utility companies—probably carrying more debt than they are now really comfortable with—see others getting away with it, even they could be tempted to follow suit.

[Since] I have no need to needlessly raise our risk profile, I have turned to another tried and tested earner, the addictive weed. The market collapse has left yields on the major tobacco companies at almost unprecedentedly generous levels, and I can no longer resist British American Tobacco (LSE: BATS; NYSE: BTI).

It recently celebrated its centenary, but has only existed in its current stock market form as a “pure” tobacco company for some ten years. During that time it has delivered 11% compound growth in earnings per share, and even faster dividend growth as the payout ratio has been raised from 50% to 65% of net earnings. The historical yield is nearly 5%, and even if they deliver slower than average earnings growth in the immediate future, the group still ticks all my key boxes. [At Monday's London closing price of 1725 pence, the stock had a trailing yield of 4.85%—Editor.]

BAT does have a lot of borrowings—over GBP 9 billion, compared with shareholder funds of under GBP 7 billion at end-December 2008, but the company has had no trouble in raising a further 16-billion-euro loan since and is surely low on any sensible bank’s list of potential bad risks.

Of course there are all the usual worries about health, lawsuits, government regulation and piracy, but life in the nicotine world was ever thus. The ex-dividend date is early August, and in the unlikely event that the price should dip by 10% or more between now and then, the portfolio will buy another unit.

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