Over the past 12 months, shares in British American Tobacco, one of the largest cigarette companies in the world, have plunged by nearly 31% excluding dividends. Over the same period, the FTSE 100, has fallen by just 4%.

In other words, since mid-October 2017, shares in BATS have under performed the broader market by 27%.

For a company like BATS, which is widely considered to be one of the most defensive investments around, this under performance is staggering. If we include dividends the performance figures are only slightly better. The stock’s total return over the past 12 months is -25%.

What’s behind the decline?

It is difficult to pin down one specific reason why the shares have under performed over the past year. Regulators in the US have hinted at the possibility of additional regulation for the tobacco sector, but this is nothing new. For the past four decades, tobacco companies around the world have been fighting off legal challenges and adapting to new regulations, so it is unlikely a new set of rules for the sector will result in a significant upset.

The company is investing heavily in so-called reduced risk products, such as heat not burn cigarettes and vaping. BATS believes these products are the future and management thinks they will become a significant part of the business over the next few years. Incoming chief executive Jack Bowles thinks this is where the company will excel over the next few years. “With our pipeline of potentially reduced risk products, I am confident we will take full advantage of these opportunities as we accelerate the transformation of BAT into a stronger multi-category tobacco and nicotine products company,” he declared recently.

Time to buy?

What does this all mean for investors? Well, it looks to me as if BATS’s future is not as bleak as the market is indicating.

Right now, the stock is trading at a forward P/E of just 11, which is significantly below the long-term average valuation for the business. Indeed, over the past five years, the stock has traded in a P/E range of between 15 and 23.5. The current valuation is the lowest recorded so far this decade.

At the same time, as the value of the shares has fallen, the dividend yield has spiked. Today shares in a company support a yield of 5.8% rising to 6.2% for 2019 according to current City estimates.

These figures seem to suggest that right now, shares in BATS are on sale and I’m looking to take advantage of the market’s ambivalence towards the company. The firm has been a reliable income and growth stock over the past few decades, and I don’t expect this trend to come to an end anytime soon. The City is expecting earnings per share to expand by around 30% over the next two years, which appears to support my thesis.

Disclosure: The author owns shares in British American Tobacco.


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