Tobacco bulls such as Neil Woodford, Invesco Perpetual’s Mark Barnett and Fundsmith’s Terry Smith have taken a huge boost from a rally in tobacco stocks over the past year, according to data from FE Analytics.
The likes of the Imperial Tobacco and British American Tobacco – the two constituents of the FTSE All Share Tobacco index – have seen a rapid upward movement that is well ahead of the broader movements in equity markets, albeit with some volatility.
According to FE Analytics, over the past year the FTSE All Share Tobacco index has gained 16.62 per cent over while the FSTE All Share has returned 8.1 per cent.
Performance of indices over 1yr
Source: FE Analytics
However, as the graph above shows, tobacco stocks’ outperformance of the wider market came predominately in the opening half of this 12-month period. Although the stocks have continued to rise over the past six months, they have slightly lagged the gains in the All Share.
Mark Barnett, head of UK equities at Invesco Perpetual, holds both BAT and Imperial Tobacco as top positions in his £6.9bn Invesco Perpetual Income and £12.9bn Invesco Perpetual High Income funds, while also holding US-listed Reynolds American in both portfolios’ top 10s. In total these stocks make up about 15 per cent of each fund.
The two funds benefited hugely from a strong rise in all tobacco stocks, Barnett said when recently commenting on his first year running the portfolios following Neil Woodford’s departure after 25 years at the firm. Over this time Woodford’s fondness for tobacco stocks was well-documented.
Reynolds American’s share price rose by 70 per cent whilst Imperial Tobacco’s share price gained 36 per cent (both in sterling terms, total return) in the year to 28 February 2015, which approximately spans Barnett’s first year as manager of the portfolios.
This boosted Invesco Perpetual Income and Invesco Perpetual High Income to return 15.09 per cent and 15.13 per cent over the past year, about 7 percentage points more than the FTSE All Share index.
Performance of funds and index over 1yr
Source: FE Analytics
Woodford, whose £5.5bn CF Woodford Equity Income fund was launched just under a year ago, also has a major position in all three companies. He has a combined 16.6 per cent of his total portfolio in tobacco.
His second largest position is Imperial Tobacco – after AstraZeneca – which is 6.8 per cent of the fund. Terry Smith, manager of the £3.5bn Fundsmith Equity fund, also has the stock as a top 10 holding.
No UK funds have nearly as much in big tobacco as Woodford and Barnett’s portfolios. The funds with next largest exposures to the ones already mentioned are Woodford’s SJP High Income, which has about 14 per cent, and Barnett’s Invesco Perpetual UK Strategic Income at 11.5 per cent.
Tobacco has also been a long-term favourite with private investors with BAT being the most popular stock to be held in ISA portfolios, according to The Share Centre, but the spectre of changing habits, the rise of e-cigarettes and punitive UK and EU government legislation such as plain packaging has raised the prospect of a hazy future for companies in the smoking business.
Helal Miah, investment research analyst at The Share Centre, says the popularity of tobacco holdings indicates the hunt for a ‘safe’ yield by income investors but he adds that there are some significant risks due to the trends in developing countries to increasingly shun smoking.
“We recommend British American Tobacco as a ‘hold’ as growth in emerging markets, product innovation and above-average income are all in its favour. However the steady decline in developed world volumes and investors’ possible move towards higher-growth sectors as the global economic backdrop improves may hinder progress in the short to medium term,” he said
Both BAT and Imperial have had a decent run over the past year but Imperial has very much lead the charge more recently making a three-fold higher return.
Performance of stocks and index over 1yr
Source: FE Analytics
Sheridan Admans, investment research manager at The Share Centre, adds that a sharp decline in volumes announced by BAT recently is a big worry for its dividend but says a possible Reynolds American-Lorillard merger in the US could be a boon for investors in the sector.
“There have been rumours that the deal will shortly receive approval from the authorities there, paving the way for Imperial to significantly increase its operations in America. The impact of exchange rate movements on earnings will also be of interest to investors but, for many, the main appeal of the stock is the dividend so there will also be a lot of attention given to that number.”
Of the 90 funds in the IA UK Equity Income sector, British American Tobacco and Imperial Tobacco are top-10 holdings with 39 and 42 respectively.
However, Ruffer’s Steve Russell also thinks the sector could be a thorn in side of equity income funds, as investors in search of yield have driven-up prices in the belief its dividend is sacrosanct but low interest rates have caused a miss-pricing soon set to blow up.