View from City Road: Smokers still support BAT

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After underperforming the stock market by 20 per cent since the start of the year, under the mounting threat of a US cigarette price war launched by the market leader, Philip Morris, BAT has recovered smartly.

Partly this is justified by half-year results right at the top end of expectations. Including a pounds 135m profit on its recent brand exchange deal with American Brands and an pounds 88m currency gain, pre-tax profits rose by 35 per cent from pounds 672m to pounds 906m.

Underlying profits on continuing operations, stripping out the effect of currencies and exceptional profits, appear to have risen by about 10 per cent led by a turnaround from losses of pounds 39m to profits of pounds 45m at Eagle Star. Even so an 8 per cent rise in the interim dividend to 7.9p was better than many had forecast.

But the recent share-price recovery also owes something to the fact that once Philip Morris's phoney war over Marlboro finally broke out into open hostilities the stock market knew where it was. From 9 August BAT's Brown & Williamson will cut its prices by up to 20 per cent on all premium brands to match Philip Morris, causing a nervous 4p retreat to 445.5p in BAT's shares.

A dollars 75m stock write-down at Kool and a severe drop in German profitability pushed tobacco trading profits 6 per cent lower to pounds 468m, excluding the brand swap profit.

The permanent impact on BAT of US price cuts - at an annual rate possibly between pounds 133m and pounds 166m - will appear from next month.

Brown & Williamson is relatively fortunate in that two-thirds of the 55 billion cigarettes it churns out every year are value-for-money products where it is seeking mild price rises.

None the less tobacco will be growing from a lower base. Any reasonable valuation of BAT's financial services side still implies a mid-single figure p/e for tobacco where export markets, aside from a few coughs and splutters in the Middle East and China, offer good prospects.

This underpinning and an above-average dividend growth, combined with a yield of 5.6 per cent, ought to retrieve support for the shares.