The last six months have been very positive for investors in British American Tobacco (LSE: BATS). Shares in the company have risen by 10%, while the FTSE 100 is up just 2% over the same time period.
However, the Labour Partys annual conference knocked shares back somewhat this week as leader Ed Miliband announced a new tax on tobacco firms based on their market share. Despite this, British American Tobacco appears to be well worth buying heres why.
As mentioned, the new tax would be based on a tobacco companys market share and would be used to pay for smoking-related illnesses on the NHS. While this would lead to higher costs for British American Tobacco and its peers, British American Tobacco currently only accounts for around 8% of UK sales of cigarettes, with rivals Imperial Tobacco and Japan Tobacco being the major players.
In other words, a tax based on market share would hit British American Tobacco to a far lower extent than its peers and could serve to strengthen its relative global position in the industry.
Of course, it is almost a certainty that any new tax on tobacco companies will simply be passed on to consumers via higher prices. Indeed, there is little evidence to suggest that price increases dissuade people from smoking. In the last 10years and despite hefty price increases, the proportion of UK adults who smoke has remained at around 20%. Therefore, tobacco companies such as British American Tobacco have scope to pass on higher taxes to consumers and maintain their strong bottom line growth.
Despite its huge potential in the e-cigarette market and its well-diversified portfolio of brands and global footprint, British American Tobacco continues to offer good value for money.
Shares in the company currently trade on a price to earnings (P/E) ratio of 15.8, which seems to be relatively low when compared to other global consumer stocks. For example, Unilever and SABMiller have P/E ratios of 19.7 and 22.2 respectively, which shows there could be upward rerating potential for British American Tobacco.
Allied to this is an impressive yield of 4.1%, as well as the potential for above-inflation dividend growth over the long run.
So, while a further tax on tobacco may seem like bad news for British American Tobacco, it looks set to be simply passed on to the consumer. With a low relative valuation, a small UK market share, income potential and a growing e-cigarette operation, British American Tobacco looks like a top notch buy that is available at a keener price (for now) after the Labour Partys recent announcement.
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Peter Stephens owns shares in British American Tobacco, Imperial Tobacco and Unilever. The Motley Fool owns shares in Unilever.