If I asked you to name a sin stock, youd probably suggest British American Tobacco (LSE: BATS)).
You probably wouldnt mention the UKs sugar giants, Associated British Foods (LSE: ABF) (NASDAQOTH: ASBFY.US) and sweetener manufacturer Tate & Lyle (LSE: TATE).
Despite this, recent press coverage has suggested that both sugar and sweeteners could be linked to the wests obesity and diabetes epidemic. This view isnt yet universally accepted, but the evidence is mounting, and I believe investors need to consider the potential implications.
Tobacco 2, Sugar 0
Although sugar producers are never likely to face the kind of regulatory pressure under which tobacco firms trade, they do have a number of disadvantages, in my view:
|
Tobacco firms |
Sugar producers |
|
Consumers are intensely loyal to global brands, which drive premium pricing power and high profit margins. |
Sugar and sweeteners are essentially commodities, the price of which can be driven down by excess supply. |
|
Regulatory restrictions are well understood and managed by the industry. Scientific evidence against tobacco is mature and no longer controversial. |
Potential for future regulation or dietary changes by consumers is completely unknown. Scientific evidence still mounting against sugar. |
Having reluctantly accepted that tobacco is harmful, the growth of unregulated e-cigarettes is an example of how the tobacco industry is seeking to adapt to declining levels of smoking in Western countries.
BAT has recently gone a step further, backing a small British start-up firm thats launching a medically approved nicotine inhaler, targeting mature smokers in western markets!
What about the financials?
Leaving the arguments aside, how do the numbers look? Are any of these firms a compelling buy in todays market?
|
|
Associated British Foods |
Tate & Lyle |
British American Tobacco |
|
2014 forecast P/E |
25.7 |
14.8 |
16.9 |
|
2014 prospective yield |
1.3% |
3.9% |
4.1% |
|
Operating margin |
8.0% |
10.3% |
38% |
BATs incredible profit margins mean that it can afford to service a substantial debt pile and pay generous dividends to shareholders. With a P/E of nearly 17, BATs shares are fully valued, but this reflects the demand for income in todays market.
In contrast, ABF looks plain expensive, with an uncomfortable forecast P/E of 25.7%, the lower profit margins of the three, and an unappealing 1.3% prospective yield.
Tate & Lyle is the cheapest of these three firms and offers a decent yield. However, weaker demand and pricing pressure on its key Sucralose product has triggered two profit warnings so far this year, and despite managements reassurances, Im not completely confident a third disappointment wont be on the cards.
Todays best buy?
In my view, ABF is simply too expensive, given its low yield and weak growth prospects.
Tate & Lyle looks a reasonable buy despite the risk of further profit weakness this year, but the strongest contender for income has to be British American Tobacco.
BATs high profit margins and low capital expenditure mean that it generates a lot of free cash flow, virtually all of which is returned to investors each year. I cant see this changing in the near future.
A top buying tip
Over the last ten years, British American Tobacco has delivered an average total return of almost 19% per year — more than double the 7.8% the FTSE 100 has delivered over the same period.
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Roland Head has no position in any shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
