Few goods are as defensive in nature as tobacco products. Whether unemployment is at 4% or 10%, investors in the likes of British American Tobacco (LSE: BATS) can rely on smokers continuing to purchase cigarettes, smokeless tobacco and, increasingly, e-cigarettes. These steady sales, exposure to growth markets in the emerging world, and unbelievably high margins make BAT one stock I’d buy now and feel comfortable holding for years and years.
While the market for cigarettes is undoubtedly contracting in the west, BAT was able to increase its total tobacco volume sold in 2016 by 0.1%. This was accomplished by selling more non-cigarette products, tapping into customers in developing countries eager for Western brands, and acquiring smaller competitors.
But the company isn’t just relying on slow volume growth to improve profits. Rather, it is doing what it has always done: improving margins by hiking prices and cutting costs. In 2016 these efforts improved operating margins to 37.1%. This resulted in a 6.9% rise in constant currency revenue and a 10.4% leap, year-on-year, in adjusted earnings per share on a constant currency basis.
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There’s room for margins to continue expanding if BAT is successful in its $49bn bid for the 60% of Reynolds American it doesn’t already own. The company reckons it will be able to cut some $400m in annual costs by 2019 while growing market share in the incredibly profitable US market and adding exposure to growth markets overseas.
With organic growth and acquisitions growing the top line, unbeatable pricing power leading to stunning margins and profits, and a 3.32% yielding dividend, I reckon BAT is one share to love for the long term, especially as it’s currently priced at a reasonable 17 times forward earnings.
Another option that’s easier on your conscience
But if sin stocks aren’t your cup of tea, I also think that pharmaceutical giant GlaxoSmithKline (LSE: GSK) could be a fantastic buy-and-hold investment. The reason I prefer GSK to its competitors is because the company has a very diversified business model that supplements the high growth but cyclical pharma business with steady sales from its consumer healthcare and vaccines divisions.
In 2016 each of these three divisions posted positive sales growth, with vaccines and consumer healthcare products especially impressive at 14% and 9% year-on-year growth, respectively. While the pharmaceutical business only grew sales by 3% year-on-year this was still an impressive tally given the fact that the blockbuster respiratory treatment Advair went off patent in the US.
And in the long run the cutting edge research GSK is known for is still set to pay dividends as sales from the company’s new drugs doubled year-on-year to £4.5bn. A particular bright spot was a group of new HIV treatments whose sales rose 82% year-on-year to £2.7bn.
I also like that the business is highly cash generative with some £3bn in free cash flow generated in 2016 alone. This provides the firepower to provide shareholders with a dividend that currently yields 4.8%. With earnings rising, strong growth prospects and an attractive valuation of 15 times forward earnings, I reckon now is a great time to take a closer look at GSK as a long-term holding.
