LONDON -- With governments across the world enacting various pieces of legislation aimed at reducing the number of people who smoke, many investors are questioning the merits of investing in the tobacco sector.
Indeed, even the second-biggest cigarette market in the world, Russia, recently banned smoking in some public places. This follows Australia's plain-packaging law in December, which required all cigarettes to be sold in identical, dark-green packets.
The tide, it seems, is turning against tobacco companies such as British American Tobacco (BATS 3.56%) (BTI 3.40%).
However, while smoking tobacco may be a declining activity, a new and supposedly healthier variant could be the answer to the industry's prayers.
Indeed, BAT announced earlier this year that it has appointed its former group operations director, Des Naughton, as managing director of its Next Generation Products division.
Alongside him will flow substantial investment, with the company expecting approval for a new "tobacco inhalation device" (which is not an electronic cigarette) by the end of this year. Furthermore, BAT hopes the product will launch by the end of 2014 and will be the change that is needed to offer a viable long-term future for the industry.
As mentioned, worldwide cigarette volumes are currently in decline, although with the world population forecast to hit 9 billion by 2050, a falling proportion of smokers may not equate to a decline in the total number of smokers. Whether lower cigarette volumes is due to government policies is debatable but, in any case, companies such as BAT are feeling the pinch.
As a result, tobacco firms are having to increase prices and reduce costs to deliver earnings per share (EPS) growth, but such measures cannot continue indefinitely, with growing revenue being a prerequisite of long-term survival for the industry.
Therefore, new products such as BAT's tobacco inhalation device could be the structural shift that encourages more people to smoke, thereby arresting the current decline in cigarette volumes.
Of course, BAT not only offers long-term potential but the chance to make short-to-medium-term gains, too.
With a P/E of 15.4 and annual EPS growth of around 9%, the shares do not seem to be overly expensive, especially when compared to the tobacco sector P/E of 16.3. A yield of 3.9% is above the FTSE 100 average of 3.4%, too.
As ever, government regulation remains a factor in the industry, but instead of viewing it as a negative, I would urge you to look upon it as a positive catalyst for change and quite possible as a once-in-a-lifetime opportunity for tobacco shareholders.
Perhaps it is a push from governments that will, ironically, lead to the long-term survival and profitability of not only BAT but the entire industry.
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