Investment Column: Addicted to the dividend income at BAT

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The Independent Online

Our view: Hold

Share price: 2611p (-20p)

British American Tobacco's products have deadly health consequences for most of its long-term customers, but the world's second-largest quoted cigarette-maker gave investors several reasons to be cheerful yesterday.

While underlying sales volumes fell by 1.8 per cent in its first quarter, this was better than the 2.5 per cent decline pencilled in by some City analysts. Those holding its shares will have also been pleased with the 5 per cent uplift in organic revenues at constant currency over the three months to 31 March, which in the face of declining volumes showed how successful BAT has been at pushing through price increases.

While the truth may be unpalatable for some, the willingness of addicted consumers in countries from Pakistan to Turkey to smoke the company's products irrespective of price rises has long been at the heart of the investment case behind defensive stocks, such as BAT.

Despite intense pressure on consumers' wallets in many of its markets globally, BAT's sales volumes from its subsidiaries declined by only 2.4 per cent to a mind-boggling £164bn over the period. It was hit by "significant" declines in markets such as Spain, Mexico, Australia and Vietnam. But BAT said it grew market share in all these countries, helping it boast continued share gains of 30 basis points in its top 40 markets.

Of its brands, BAT announced a strong performance from its biggest selling and premium brands, which bodes well for margins at the tobacco giant. For instance, the group's four "global drive brands" – Kent, Pall Mall, Dunhill and Lucky Strike – posted a combined 9 per cent rise in volumes over the quarter. The star performer was Kent, with sales volumes up 16 per cent, boosted by barnstorming demand in Russia, Japan, South Korea, Romania and Ukraine. At an operational level, the group continues to tackle its cost base – citing, among other initiatives, the closure of some factories in Europe, as well as "downsizing" its manufacturing facilities in Australasia.

Overall, for those looking for dividend reassurance, BAT has a strong track record of growing its dividend per share and the net yield of 5.1 per cent for 2012 also looks attractive. Equally tempting is that BAT plans to buy back £750m worth of shares this year, continuing its repurchase policy.

Still, shares in BAT have surged since sinking to a 12-month low of 1950p last May and now trade on a price-to-earnings ratio of 12.5, which makes us cautious until they cool down. We also note that BAT said its recent performance was delivered in "trading conditions which remain challenging, with industry volumes markedly lower in a number of markets". For investors in need of a defensive fix, we recommend they buy BAT for the long term. But for those seeking smoke signals of a rising share price, we suggest leaving BAT on the shelf for the time being.

Stagecoach

Our view: Buy

Share price: 246.9p (+10.4p)

Stagecoach put out a trading update yesterday to warm the cockles of existing investors and possibly to encourage others to get on board. The rail and bus operator said profitability in the financial year to date had remained strong "with good ongoing cost control and all divisions showing revenue growth".

As this was just an indication released shortly before the preliminary results, the numbers were fairly sparse. But those that were on display were solid. In the 48 weeks to 3 April, the UK bus division rose 2.2 per cent and rail rose 6 per cent. The North American business strengthened 8.3 per cent, with plans in place for further expansion, and Virgin Rail Group rose 12.1 per cent. The management added that the outlook was good saying the prospects "remain positive".

The shares have performed well over the past month, especially following idle gossip that Deutsche Bahn among others were keen to buy it. The group also benefited from making the shortlists of two rail franchises. However, issues that might dampen enthusiasm include bus concessionary support and fuel costs, according to Peel Hunt analysts.

Still, the price is standing at about 10 times estimated full-year earnings, which Panmure Gordon analyst Gert Zonneveld called "undemanding". Highwaymen used to hold up stagecoaches and demand "your money or your life". Potential investors should not need such threats. Buy.

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