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Anyone who bought British American Tobacco (LSE:BATS) shares in the last 12 months is sitting on an unrealised loss (unless they sold them already). The stock is at a 52-week low.
At £24.86, the share price is back where it was in 2011. But is a 9% dividend yield from a company with increasing revenues, margins and profits too good to ignore?
Fundamentals
At first sight, the company’s fundamentals look good. At a basic level, the firm makes a product that’s cheap, addictive, and sells it to a customer base that tends to be loyal to its preferred brands.
Over the last decade, this has resulted in some impressive numbers. Revenues have grown at an average of 6% per year, margins have expanded, and the dividend has gone from £1.38 to £2.18.
This looks difficult to argue with. But beneath the surface, there are some red flags for investors to be aware of.
First, a closer look at the revenue line shows something interesting. While 10-year growth averages 6%, over the last five years, sales have only increased by an average of 2.5% per year.
On top of this, the company’s growth has been financed by equity. As a result, the number of shares outstanding is 10% higher than it was a decade ago, diluting the effect of that growth.
Neither of these is positive and investors will want to keep an eye on these going forward. Both might go some way to explaining why the stock has been steadily moving lower since 2017.
Outlook
Recent issues notwithstanding, the company has an enviable record of growth. And at a price-to-earnings (P/E) ratio of 6, it looks cheap relative to the rest of the FTSE 100.
Investors today aren’t buying a share of the company’s historic profits, though. Rather, they’re buying a stake in the company’s future – so what does that future look like?
Like most tobacco companies, British American is hoping the number of smokers doesn’t decline by too much. But this looks unlikely to me.
Almost 70% of the company’s sales come from the US (45%) and Europe (23%). But the demographics in these areas don’t look favourable for the future of smoking.
First, the proportion of smokers in both regions is declining. This is true across the globe, but it’s especially true in developed economies, such as Europe and the US.
Second, the birth rates in both regions are low. This means that the proportion of people smoking is going down and the population as a whole is declining. Together, I think these create a powerful headwind for the business.
Foolish takeaways
With British American Tobacco, the cash it generates in the short term might justify an investment at today’s prices, despite some long-term headwinds. But that’s not my style as an investor.
When I invest, I look for stocks that I can buy and hold for the long term. This means companies that are going to be in a strong position 30 years from now.
British American Tobacco doesn’t fit that profile, so it’s not a stock for me. But I do accept that there’s not been a better buying opportunity here since 2011.
