BAT burns up the City trail

SHARES Better prospects for the tobacco industry have given Britain's seventh largest company a boost
SELLING life insurance to smokers would not, you would have thought, be a sure fire way to make money. BAT Industries, though, on course for pounds 2.5bn pre-tax profits this year, literally makes a packet out of it - as well as selling life, pensions and other insurance to millions of non-smokers in Britain and America and 1.8 billion of cigarettes a day worldwide. But through a quirk of history, it hardly sells a "stick", the tradeterm for cigarettes, in Britain.

That makes BAT the world's second-biggest tobacco company behind Marlboro owner Philip Morris and the biggest UK-based insurance firm. In its figures for the first nine months of 1995, announced last week, net premium income at Eagle Star and Allied Dunbar in the UK and BAT's Farmers insurance in the US totalled pounds 6.99bn against the Prudential's pounds 3.55bn.

Like all insurers, BAT is finding life and pensions business tough at the moment, and low consumer confidence has not been helped by Britain's pensions mis-selling scandal. Still, it managed to push total financial services profits up 19 per cent, assisted by Eagle Star Direct, its belated entry into telephone sales that now has more than 500,000 customers.

The star performer, though, is still tobacco, where a 34 per cent leap in profits propelled the nine-month figures to pounds 1.81bn, prompting a clutch of forecast upgrades.

BAT shares closed the week 18p up at 544p as a result, a remarkable turnaround from a three-year low of 381p in mid-1994, at the height of fears of US tobacco lawsuits and penal health taxation, as well as the tail end of a vicious price war. Those worries have taken a firm backseat, however. And with more growth to come, a progressive dividend policy and a prospective yield of 6 per cent, the shares still have further to go.

"If you're looking at the big yield stocks in the market place, BAT has always looked cheap," says analyst Jonathan Sheehan at broker Credit Lyonnais Laing. "It does look cheap when you look around at international tobacco ratings."

BAT's uniqueness may partly explain the lag. Now that Rothmans has been taken private, it is the UK's only proper quoted tobacco stock. Hanson, which owns Imperial Tobacco, is simply too diverse for comparison. And, confounding the doom mongers of yore, tobacco is now very much a growth industry for western firms as new markets open up.

BAT has new ventures in Hungary, the Ukraine, Russia, Uzbekistan and Cambodia, and hopes to buy a factory in Poland before the end of the year. China's vast market, too, is on the agenda as the group hopes to sell its brands - including Lucky Strike, Kent, State Express 555 and Benson & Hedges - to an aspiring audience.

The group was also arguably the main victor of the US price war started by Philip Morris on "Marlboro Friday" back in April 1993. Last year, it picked up squeezed rival American Tobacco in a $1bn (pounds 637m) deal that sceptics doubted, but now seems a song given the recovery in fortunes since.

A pointer to a possible near term re-rating is that BAT's share price this year tracked that of Philip Morris closely until August, when PM shot off ahead. True, PM has been boosted by talk of demerger of its food interests, but so has BAT. The underlying reason, analysts say, is the revaluation of tobacco earnings in the US that may yet have a knock-on effect here.

As for demerger speculation, given BAT's history, that will never go. The group was founded at the turn of the century following a transatlantic trade war started by US tobacco magnate "Buck" Duke. Imperial was formed in the UK at the same time and the subsequent truce explains why BAT - British American Tobacco - exports from, but does not sell into, the UK.

By the 1980s, the group had used its huge cash flow to move into paper making, retail, cosmetics and - after current chairman Sir Patrick Sheehy took up the reins in 1982 - insurance. Raider Sir James Goldsmith launched his abortive multi-billion "unbundling" bid in 1989 and the rest is history. Paper maker Arjo Wiggins Appleton, retailer Argos and the Saks Fifth Avenue department store in New York were spun off, leaving insurance and cigarettes behind - and perennial talk of demerger Mark 2.

Still, against just pounds 2bn in 1982 BAT is now valued at nearly pounds 17bn, making it the UK's seventh biggest company. And the shares are a firm buy on fundamentals in most brokers' books.

BAT Industries

Share price 544p

1993 1994 1995* 1996*

Sales pounds 11.8bn pounds 12.2bn N/A N/A Pre-tax profits pounds 1.81bn pounds 1.8bn pounds 2.4bn pounds 2.6bn Earnings per share 38.5p 39.1p 48p 52 Dividend per share 20.1p 21.9p 23.9p 26 P/E ratio - 13.9 11.3 9.7 Gross yield - 5.4 5.9 6.4

* Estimate

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