Should I Invest in British American Tobacco?

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators, and buy at prices that offer decent value.

This series aims to identify appealing FTSE 100 investment opportunities, and today, I'm looking at British American Tobacco (LSE: BATS  ) (NYSEMKT: BTI  ) , the cigarette maker.

With the shares at 3,632 pence, BATS's market cap. is 69,797 million pounds.

This table summarizes the firm's recent financial record:

Year to December 2008 2009 2010 2011 2012
Revenue (million pounds) 12,122 14,208 14,883 15,399 15,190
Net cash from operations (million pounds) 3,539 3,878 4,490 4,566 4,427
Adjusted earnings per share (pence) 129.6 153.8 176.7 195.8 208.6
Dividend per share (pence) 83.7 99.5 114.2 126.5 134.9

British American Tobacco continues to win market share against a background of declining cigarette volumes in the industry as a whole. Indeed, pockets of growth, such as in Indonesia, the Middle East, South Korea, Germany, Poland, Pakistan, Chile, Canada, and Italy, are tending to be offset by declines in places like Brazil, Russia, Japan, Spain, the Middle East, Uzbekistan, and Spain. That strikes me as being a bit like winning an up race on a down elevator. The firm's active share-repurchase program can't keep the share price alight forever.

The addictive nature of the product makes the shares defensive, and they've had a good run recently. But with the directors talking of fragile markets, the forward dividend yield of around 4.5% doesn't tempt me, as the other half of the total-return equation, capital gains, seems vulnerable.

British American Tobacco's total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

  1. Dividend cover: adjusted earnings covered last year's dividend around 1.5 times. 3/5
  2. Borrowings: net gearing is around 111%, with net debt about 1.6 times operating profit. 4/5
  3. Growth: flat revenue and cash flow with rising earnings.3/5
  4. Price to earnings: a forward 14.5 looks full against growth and yield expectations. 3/5
  5. Outlook: satisfactory recent trading and a cautiously optimistic outlook. 3/5

Overall, I score BATS 16 out of 25, which inclines me to be cautious about the firm's potential to outpace the wider market's total return, going forward.

Foolish summary
This is a neutral set of numbers against my indicators, and insufficiently exciting to tempt me into buying or watching the shares. However, a decent forward yield, and under-control debt, may encourage some income seekers.

BATS isn't for me, but when it comes to dividend yield, I'm excited about an idea from The Motley Fool's top value investor, who has discovered what he believes is the best income-generating share play for 2013. He sets out his three-point investing thesis in a report called, "The Motley Fool's Top Income Share for 2013," which I recommend you download now. For a limited time, the report is free; to download it immediately, and discover the identity of this dividend-generating star, click here.


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