If someone tells you that there aren’t any bargains to be had in today’s market, they aren’t looking hard enough. Take British American Tobacco (NYSE:BTI), for example. I’m bullish on the London-based tobacco and nicotine products giant, as it trades for an insanely cheap valuation, features a monster dividend yield, and has a business model that, while facing challenges, has stood the test of time for well over a century.
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Scrap Heap Valuation
Shares of BTI trade at a ridiculously cheap valuation of just 6.6 times earnings. This is a profound discount to the broader market. The S&P 500 (SPX) currently has a valuation of about 19 times earnings.
Obviously, tobacco is not known for being a high-growth business, so some discount to the broader market is understandable. But BTI is also cheaper than tobacco peers like Philip Morris (NYSE:PM) and Altria (NYSE:MO), which trade at 14.8 and 8.6 times earnings, respectively.
A stock trading for a paltry valuation like this leaves plenty of room for upside while also providing some downside protection.
Dividend Yield
Not only is BTI stock cheap, but it also sports a monster dividend yield. Shares currently yield an incredible 9.7%. This yield crushes the average dividend yield for the S&P 500 (which currently stands at 1.6%), and it’s also double the yield of 10-year Treasury bonds (currently 4.83%).
This is still a supremely attractive yield, even in a rising rate environment that has made many dividend stocks with relatively high yields seem far less compelling to investors.
Furthermore, while an abnormally-high dividend yield can sometimes be a red flag that a stock will reduce or completely cut its dividend, BTI is profitable and produces plenty of free cash flow to cover its dividend payment, so this doesn’t seem like much of a risk here.
Rolling with the Punches
Like most stocks with valuations this low and dividend yields this high, BTI has its challenges to deal with. Investors tend to dislike the tobacco business in general. Furthermore, the company was recently dealt a regulatory blow when the FDA banned the sale of its popular Vuse Alto menthol and mixed berry flavored e-cigarettes in the United States. European regulators have also implemented an upcoming ban on the sale of flavored heated tobacco products in the European Union.
While these are indeed blows, this bad news is already priced into the stock. That’s why shares trade at 6.6 times earnings and yield over 9%. But as we’ll discuss below, the company is far from being left for dead.
BTI is rolling with the punches and already has a counter to the European Union ban: heat sticks made from nicotine-infused rooibos tea rather than tobacco. It’s not yet clear whether the products will be a hit, but industry participants seem to believe in it. BTI also plans to roll the product out globally, and Philip Morris has touted its own plans to roll out its own zero-tobacco stick this year.
Because they wouldn’t fall under the category of heated tobacco, these rooibos tea sticks would be free to come in popular flavors like menthol and berry, potentially bolstering sales.
Meanwhile, BTI immediately challenged the FDA ban on its flavored Vuse products. The company is seeking a stay of enforcement, so the book is certainly not closed on this chapter yet.
More than Just a Cigar Butt
In his 1989 shareholder letter, Warren Buffett famously coined the concept of “cigar butt investing,” comparing buying beaten-down stocks to picking up a cigar butt off the street to enjoy one last puff of it before it burns out.
While the analogy may seem apropos here (not least of all because BTI is a beaten-down tobacco and nicotine stock), the stock is more than just a cigar butt with one puff left. The company has been around since 1902, so its business model has proven to be durable over many years. It may even have some significant growth drivers up its sleeve if products like its glo tobacco heating products or its nicotine-infused rooibos tea products prove to be hits.
There certainly seems to be some growth potential for these new types of products. When BTI last reported half-year results, overall revenue was up 4.6%, while revenue from New Categories (which includes its various non-cigarette products such as Vuse e-cigarettes and glo tobacco heating products) grew by 26.6% year-over-year.
Is BTI Stock a Buy, According to Analysts?
Turning to Wall Street, BTI earns a Hold consensus rating based on zero Buys, three Holds, and zero Sell ratings assigned in the past three months. The average BTI stock price target of $33.00 implies 13.9% upside potential.
Investor Takeaway
The stock certainly won’t win any beauty contests, but I’m bullish on BTI, given its ultra-cheap valuation and its sustainable dividend yield of over 9%. The stock faces some challenges, but its business has been around for well over 100 years, and it will continue to persist. The company has some potential solutions to the challenges it faces, and the growth potential of its New Categories products means that it is more than just a “cigar butt investment.”
