5 Reasons to Put Tobacco in Your Pension
LONDON -- Identifying shares that can be safely stashed away in your pension and left to deliver the goods for 20 years isn't easy, but I have a couple of suggestions.
British American Tobacco (ISE: BATS.L) and Imperial Tobacco (ISE: IMT.L) are the second- and fourth-largest tobacco companies in the world. Between them, they sold 1.1 trillion cigarettes last year to smokers all over the world.
Ethical investors may balk at tobacco's undeniable health risks, but purely from an investing point of view, these two companies make good sense.
So here are five reasons to consider putting tobacco shares in your pension portfolio:
1. Reassuring size
Both BAT and Imperial are large FTSE 100 companies with more than 100 years of successful trading behind them. They should be fairly safe homes for your cash over long periods of time.
Here's a quick look at the essential statistics of each company:
2011 Pretax Profits
Cigarettes Sold (2011)
British American Tobacco
65 billion pounds
4.9 billion pounds
Lucky Strike, Dunhill, Pall Mall, Kent
24 billion pounds
2.1 billion pounds
Davidoff, Gauloises Blondes, West, Lambert and Butler, JPS, Golden Virginia
*Includes cigarette equivalents such as cigars.
2. Big profits = big dividends
All of the big tobacco companies have spent many years working hard to consolidate and cut costs. This has been done mostly through acquisitions, and the resulting economies of scale have created some very lean and efficient operations.
BAT enjoys especially impressive profit margins. During 2011, for instance, the firm delivered an operating margin of more than 35%. In addition, spare cash and a mature business mean plenty of dividend potential: BAT's dividend policy is to pay out an impressive 65% of earnings each year to shareholders.
Assuming that BAT manages to sustain earnings growth at or above the rate of inflation, shareholders should collect an inflation-beating dividend rise every year!
BAT's huge profit margins seem to be derived from its larger size and emerging-market strength. Imperial's operating margin was only 9.5% in 2011, and this figure has fallen steadily from 15.4% in 2008.
BAT and Imperial both currently offer dividend yields of around 4% -- above average for the FTSE 100 and an attractive yet sustainable level.
3. Wide moats
An economic "moat" reflects a company's competitive advantage. Typically, it represents a high barrier to entry that can produce above-average profits as potential competitors are stopped from competing on even terms.
The big tobacco companies all benefit from wide moats thanks to their large scale, multiple brands, and addictive products.
Smokers do not tend to stop smoking when money is tight; they are more likely to simply switch to a cheaper brand, which will quite often be made by the same company as their previous brand. Imperial Tobacco, for example, has a 45% share of the U.K. cigarette market.
4. Home and away
BAT was originally formed in 1902 as a joint venture between Imperial Tobacco and the American Tobacco Company. BAT's purpose was to develop the cigarette trade in emerging markets, and this strategy has been highly successful: Today, BAT is more than twice the size of Imperial Tobacco.
BAT's global footprint is one of its key strengths, protecting it from regional downturns and giving it access to expanding emerging markets, where increasingly wealthy consumers are moving from cheap local names to fashionable global brands:
Eastern Europe, Middle East, and Africa
By contrast, 65% of Imperial Tobacco's profits came from EU countries in 2011, which is probably why its growth has fallen behind that of BAT since 2009.
5. The choice of experts
My pick of these two shares would be BAT, but one man who really knows how to identify a profitable long-term holding is Neil Woodford, one of the City's most successful fund managers. Tobacco shares make up 16% of the 20 billion pound portfolio he manages for private investors like you and me.
Woodford's record is one of the best in the City. Between 1996 and 2011, his stock choices rose in value by up to 347%, outperforming the 42% gain of the wider market by a huge margin. You can read why Neil Woodford bought BAT and Imperial -- as well as his other favorite holdings -- in this special free report. The Motley Fool's "8 Shares Held By Britain's Super Investor" is currently free to download and carries no obligation, but hurry -- it's available only for a limited time.
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The article 5 Reasons to Put Tobacco in Your Pension originally appeared on Fool.com.Roland does not own shares in any of the companies mentioned in this article. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.