Questor: an expected yield of 7.4pc and even a rise in the dividend this year. Hold BAT

Questor share tip: Covid-19 may put people off smoking in the end, but British American Tobacco is still pumping out cash

Russ Mould 12 May 2020 • 6:00am

A man with smoke coming out of his mouth — Investors will have to consider whether the Covid-19 outbreak has a long-term impact on the popularity of smoking Credit: RUNGROJ YONGRIT/EPA-EFE/REX

The end of Shell’s payment streak shows that few dividends can be seen as entirely safe.

Recent soothing statements from Diageo, Reckitt Benckiser and Unilever suggest that consumer staples stocks may be a source of succour for income-hungry investors and this column will therefore continue to lean on British American Tobacco as a potential source of plump dividend payments.

A statement made at last month’s annual meeting by Jack Bowles, the chief executive, offered encouragement on this front. He reaffirmed BAT’s plan to pay out 65pc of adjusted, fully diluted earnings per share as dividends. Analysts forecast a 4pc increase in earnings in 2020, which implies both a rise in the annual dividend and a yield of some 7.4pc.

BAT still faces challenges as volumes were expected to fall once more in 2020 even before the pandemic, thanks to the ongoing regulatory pushback against tobacco consumption (and some investors will steer clear of this stock on ethical grounds).

Philip Morris, an American rival, has withdrawn earnings guidance for this year even though its first-quarter results beat forecasts.

It cited the hit to purchases of duty-free cigarettes at airports and slower adoption of vaping systems as lockdowns prevented consumers from travelling and getting out and about.

Investors will also have to consider whether the viral outbreak has a longer-term impact on the popularity of smoking. Tobacco consumption can weaken the respiratory system and Covid-19 is treating those with existing health conditions particularly cruelly.

For the moment, however, many investors will just be focused on getting through the outbreak with as little damage to their portfolios as possible and, looked at from this admittedly narrow perspective, tobacco stocks could be helpful.

In 2019 BAT’s operating profit of £9bn turned into free cash flow of £5.9bn once capital investment, tax, interest, lease payments and pension contributions were met and depreciation and amortisation added back.

That was more than enough to fund the £4.6bn annual dividend payment and even to facilitate a reduction in its substantial debt pile.

The net debt position of some £44bn, largely the result of the acquisition in 2017 of Reynolds American, should continue to come down and further reduce risk in the business. Nor is it quite the burden that it first seems when viewed in the context of £64bn in shareholders’ funds.

Only 6pc of debts were repayable within two years at the end of 2019, when 49pc of its liabilities had a maturity of five years or longer.

BAT’s formidable operating margin of 35pc also means that interest cover exceeded five times last year. Such financial solidity is an appealing feature during these testing times.

BAT will be of no interest to ethical investors but many income seekers will still warm to the stock.

Questor says: hold

Ticker: BATS

Share price at close: £30.51

Update: OneSavings Bank

Few tears may be shed for them but this is a rotten time to be a bank.

Interest rates are anchored near zero and central banks are manipulating bond yields and borrowing costs to the best of their ability, with the consequence that the margins on bank loan books are being squeezed.

At the same time, banks are being asked to offer cheap debt to consumers and corporations at a time when incomes are uncertain and a recession nearly certain, with the result that bad loan provisions seem sure to rise.

In this context, OneSavings Bank’s first-quarter update last week read pretty well, although furlough schemes and mortgage payment holidays may be sheltering the firm from the worst for now.

There may be no yield after the withdrawal of the second-half dividend last month but a “common equity tier 1” ratio of 17.2pc should see the buy-to-let lending specialist through even a grim downturn and the shares already trade at a 21pc discount to their historic tangible net asset value of 312p a share.

Times are tough for banks but at least OSB’s valuation already reflects this.

Questor says: hold

Ticker: OSB

Share price at close: 245.4p

Russ Mould is investment director at AJ Bell, the stockbroker.

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