Shares of so-called "sin stocks" were on fire last year. Businesses like liquor company Diageo
Pretty spectacular results for a historically defensive sector, eh?
Now, I don't expect such outsized returns again in 2007, but given the recent jitters that seem to be creeping into the equity markets, I believe investors should consider adding to their positions in these defensively oriented stocks. One of my favorite plays in this universe is British American Tobacco
I know it might seem a little crazy to be recommending shares of British American Tobacco given the many issues confronting the industry: declining consumption in many Western markets, higher taxes on cigarettes, and the out-and-out bans on smoking in various public locations, not to mention the ever-present liability issue. But I believe that many of these problems have already been priced into the stock, and that shares of British American Tobacco are poised to move higher due to the company's industry-leading geographic reach, the success of its global drive brands, and the fact that the stock trades at a discount to its peers.
Let's take a quick look, shall we?
British American Tobacco
British American Tobacco, more commonly known as BAT, was formed through a joint venture of the UK's Imperial Tobacco Company and the American Tobacco Company back in 1902. Today, BAT is the second largest tobacco company in the world -- behind Altria -- both in terms of revenue ($14.3 billion in sales for the nine months ended Sept. 30, 2006) and global market share (roughly 17% at the end of the same period).
While Altria might claim the title of the world's largest cigarette marketer, BAT is the company with the largest geographic reach, selling more than 300 different brands of cigarettes in roughly 180 markets worldwide. (In comparison, Altria operates in roughly 160 countries.) More importantly, BAT derives approximately 56% of its sales from growing markets in Eastern Europe, Asia, the Middle East, and Africa, where volumes are increasing 2%-3% annually. Only 28% of its sales come from Western Europe and North America, which are seeing slow declines of 1%-2% -- and where the risk of litigation also happens to be notably higher. Furthermore, BAT's large stable of local brands enables it to hold significant market share in many emerging markets, including a 23% share in Russia, a 38% share in Pakistan, and 60% shares in both the Malaysian and South African markets, among others.
This type of market penetration also makes it easier for BAT to successfully introduce its higher-margin core group of international brands - Dunhill, Kent, Pall Mall, and Lucky Strike - into these markets. These brands, which the company calls its global drive brands, grew volumes by 16% in the nine months ended Sept. 30, 2006 and made up roughly 27% of BAT's total sales, up from just 25% back in 2000. The impact of the growth of these higher-margin brands is easy to see: While overall group volumes increased just 1% for the nine-month period, revenue climbed 5% to $14.3 billion and operating profit (excluding one-time items) jumped 8% to roughly $4.2 billion.
Hmm ... revenue growth coupled with margin expansion ... not a bad mix, especially when you consider that BAT is attractively valued relative to its peers. At a recent price of $60, shares of BAT trade at roughly 14 times fiscal 2007 estimated earnings, a 12% discount to the average multiple afforded rivals such as Imperial Tobacco Group
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Fool contributor Will Frankenhoff is enjoying his time writing for The Fool more than reading The Financial Times or taking a nap. He welcomes your feedback and does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.