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Is it time to stub out tobacco shares?

Is it time to stub out tobacco shares? As BAT is hit with a £5.5bn fine, we look at the sin stocks loved by income investors

UK investors have been given jitters after cigarette maker British American Tobacco was hit with a record fine of £5.5billion.

BAT is a major stock in many investment funds in the UK, as are other major tobacco firms because they tend to produce good profits and dividends.

Shares in BAT, which manufactures Benson & Hedges, Rothmans and Dunhill cigarettes, had fallen 2.4 per cent yesterday, and closed at £35.06 on the day.

The fine follows a lawsuit in Canada in which smokers claimed they were not told smoking was bad for them. It has put a year’s worth of company profits at risk.

British American Tobacco posted profits of £4.5billion in 2014.

Almost a million Canadian smokers say they have been unable to quit the habit or have had cancer or emphysema after failing to be warned of tobacco’s risks.

Tobacco stocks are firm favourites among UK fund managers. These are behemoth businesses, known for paying a steady dividend — currently just over 4 per cent — making them especially popular in income funds.

But the share prices also tend to grow, and this makes them attractive to equity fund managers, too.

BAT has seen its share price rise from £21.43 to £35.06 over the past five years, while Imperial Tobacco’s has shot up from £26.69 to £32.10 a share in the past year.

Some 148 of the funds available to UK investors have BAT in their ten biggest investments, while 121 have large amounts of cash in Imperial Tobacco.

The Woodford Equity Income Fund, run by Neil Woodford, has 16 per cent of its money in tobacco firms including BAT, Imperial Tobacco, the makers of West cigarettes and Golden Virginia rolling tobacco, and Reynolds American, which produces Camel and Pall Mall cigarettes.

Meanwhile, Mark Barnett’s Invesco Perpetual High Income has more than 14 per cent of its £12 billion of assets in these businesses.

Research for Money Mail by ratings firm FundCalibre shows Scottish Widows Multi Manager UK Equity Income has 12.6 per cent of its cash in Imperial Tobacco, while BlackRock UK Focus has 7.6 per cent of its money in BAT.

Tobacco firms rely on loyal, addicted customers who pay top dollar for their fix — despite the number of UK smokers falling.


Latest figures show 19 per cent of Brits are smokers, down from 45 per cent in 1974, but that’s still more than 11 million people.

On top of litigation scares, tobacco firms find themselves facing an increasing amount of regulation and red tape.

July 2007 marked a major challenge for their businesses, when smoking in enclosed public areas, including workplaces, restaurants and bars, was banned.

In October this year, new rules are set to come into force which will fine drivers who are found smoking with a child in the car. Anyone lighting up when travelling with a passenger aged under 18 will face a fine of up to £50.

But fund managers are not concerned about increasing regulation. As red tape in developed nations has increased, these firms have turned their attention to countries with fewer limitations.

BAT markets its products in more than 200 countries across the globe, selling an incredible 667 billion cigarettes every year — or 21,000 every single second.

That’s not to say there are no challenges for these firms. Developing nations are starting to change their attitude to cigarettes.

China recently introduced a ban on smoking in some public areas, for example. Darius McDermott, director at FundCalibre, says: ‘Restrictions are only going to increase in the future, but tobacco companies have survived worse, and you can still make money from these shares even when things look bleak.

‘These firms tend to have a high and growing dividend yield, so for this alone they are still attractive. Good managers such as Mr Woodford and Mr Barnett know these companies and the risks of investing in them, and I would trust them to manage their investments in them over time.’ Stephen Lamacraft, fund manager at Woodford Investment Management, says: ‘Lawsuit risk has been an enduring feature of the tobacco industry for decades, and we do keep a close eye on developments.

‘However, tobacco stocks remain a core part of our portfolio and we don’t expect the latest class action to impact their attractive long-term investment prospects.’

It’s not yet clear whether BAT will pay the fine — it is seeking to appeal — but, even if it does, it seems that losing £5 billion is unlikely to shake its foundations significantly. Ian Forrest, research analyst at The Share Centre, says:

‘It’s a case of wait and see for investors. The fine is potentially significant but BAT seems fairly confident it will be overturned on appeal.

‘Tobacco firms are attractive due to the amount of cash they generate and their focus on paying rising dividends to their investors.

‘While this ruling is a potential problem, there are bright spots on the horizon with loosening trade restrictions between the U.S. and Cuba likely to drive cigar sales.’

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