Why did Imperial Brands plc and British American Tobacco plc crash last week?

The Motley Fool
British American Tobacco cigarette making equipment
British American Tobacco cigarette making equipment

Since last week's presidential election, markets around the world have been acting erratically. Rather than crashing, as most analysts predicted, equity markets have rallied to new highs after the election of Donald Trump and bond prices have collapsed.


The hunt for yield

The bond collapse has spread to so-called 'bond proxies', companies such as Imperial Brands(LSE: IMB) and British American Tobacco(LSE: BATS), which have become attractive income investments with investors as bond yields have slumped this year. Indeed, between the beginning of January and beginning of September shares in Imperial and British American rose 10% and 31% respectively. The shares also received a boost from the falling value of the pound during this period.

However, during the last few weeks the pound has regained some of its post-Brexit losses and investors have begun to sell bond proxies as inflation fears grow. This sudden change of heart has sent shares in Imperial and British American plunging by nearly 15% since the beginning of October. And the sell-off has only accelerated since last Tuesday. Over the past five trading days, Imperial is down by 10% and British American is off by 6%.

A 10% fall in the value of any share is enough to worry even the most experienced investor, but it would appear that, for the time being at least, there's no reason to be worried about Imperial and British American's recent declines.

Still attractive

Over the past week, there have been no serious fundamental changes to Imperial and British American's businesses. Yes, the pound has risen from its lows against the dollar but it's around 17% below its pre-Brexit levels, so both companies' earnings are still likely to benefit from a currency bump this year. Apart from that, the only other news that could have impacted the shares over the past four weeks is British American's (unsuccessful) offer to buy American peer Reynolds American, but this is more likely to have a positive, not negative impact on the shares.

Market jitters

Overall then, it would appear that shares in British American and Imperial dropped last week on nothing more than market fluctuations.

However, after the declines these companies once again look attractive as long-term investments. Indeed, before last week's declines, it could be argued that shares in British American and Imperial looked expensive after rallying by double-digit percentages during the first nine months of 2016. But recent declines have brought valuations back to more reasonable levels.

At the time of writing, shares in British American trade at a forward P/E of 17.5 and support a dividend yield of 3.6%. Meanwhile, shares in Imperial trade at a forward P/E of 12.2 and support a dividend yield of 4.5%. Based on these numbers Imperial is certainly the more attractive-looking investment, although if British American returns to make another offer for Reynolds American, it could be worth paying a premium to invest in what will be the world's largest tobacco company.

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Rupert Hargreaves owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.