One asset class that looks stretched is defensive high yielders, many income seekers having shifted out of cash and piled into stocks such as British American Tobacco. This firm pays a tempting 5% dividend and is perceived as being near bullet-proof. It owns iconic brands, such as Lucky Strike, Dunhill, Pall Mall and Kent, and is the world’s third-largest cigarette maker, with a 13.6% market share. But I think the stock could soon burn a hole in your pocket.
First, as tax rises and austerity measures hit home, consumers will either switch to cheaper brands or quit; witness the group’s 4% decline in like-for-like turnover in the first quarter. Next, sales in the West still face major threats from anti-smoking lobbyists and cash-strapped governments keen to raise tax revenue by hitting just such soft targets as tobacco. And while the industry has successfully pushed through price rises, the big concern is that as cigarettes become pricier, volumes will drop.
However, the real worry is the company’s hot rating. As Warren Buffett once observed, a firm’s share price will track its profits over time. Over the past decade, British American Tobacco’s earnings per share have risen by 290%, yet its stock has rocketed more than 550%. This can’t last. I rate the group on an eight-times Ebita multiple. After adjusting for the £8.8bn debt load and £1.0bn pension hole, that delivers an intrinsic worth of about £13 per share. So over the next two years, heavy capital losses could wipe out its dividend returns. Interim results are out on 28 July.
British American Tobacco (LSE: BATS), rated a BUY by Investec
Recommendation: SELL at £20.06
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments