Why I Think Shares In British American Tobacco plc Are Undervalued

I’m thinking about buying more shares in British American Tobacco plc (LON: BATS). Here’s why.

Carillion

Ethics aside, I think that tobacco is a great long term investment and that’s why I hold shares in British American Tobacco plc (LON: BATS) (LSE: BATS.L). In fact, I’m so optimistic about its long term future that I’m thinking about adding to my position when fresh capital appears in my ISA in April.

A key reason why I think British American Tobacco has a bright future is the changes which are taking place in the tobacco space. For years, it has been viewed as a quasi-utility where nothing changed except for the odd regulation here and there such as a ban on advertising and different packaging. As an aside, I don’t think that either of these measures has made a meaningful impact on reducing the number of smokers here in the UK.

Anyway, things are now rapidly changing on more than just regulations. In fact, I think that the tobacco industry is at the start of a period of rapid change which has the potential to positively catalyse the top and bottom lines of British American Tobacco. That change is centred on smokeless tobacco products such as e-cigarettes which are apparently less harmful than their ‘real’ tobacco peers. As such, demand for them has been high and could increase yet further.

E-cigarettes are unlikely to be the end game, however. British American Tobacco’s rival Philip Morris is in the process of releasing Marlboro Heatsticks which are essentially where tobacco is heated rather than burned. This could provide a neat halfway house between cigarettes and e-cigarettes and indicates that technological advancement could be just getting started for the industry as a whole.

With British American Tobacco having developed its own e-cigarette brand called Vype, its ability to engineer new products is apparent. I think this could help it to compete with rivals on the R&D front, while British American Tobacco also has such strong cash flow that if it is left behind by a new technology, it has the potential to make acquisitions so as to maintain its competitiveness in what could be a fast-changing world.

Allied to this growth potential is a highly defensive income stream. With tobacco products being exceptionally price inelastic, there is major scope for pricing improvements across the developed and developing world. These should help to offset volume declines and keep British American Tobacco’s dividend moving upwards at a steady pace.

With the company’s shares yielding 4.4%, it continues to offer a better yield than most of its peers and yet has a hugely defensive profile, too. With British American Tobacco’s P/E being 16.8 and offering a high and rising yield, defensive characteristics and growth potential within the e-cigarette space, I think its shares are undervalued. Therefore, I may reinvest some dividends from elsewhere over the coming months or fresh cash in my ISA in order to top up my position in British American Tobacco.

The author owns shares in British American Tobacco at the time of writing.

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