Why BAT and GSK could make gains as Covid-19 cases rise

Further Covid-19 restrictions announced this week could put further pressure on the British economy’s outlook. Many companies may struggle to deliver improving financial performances, which could lead to weaker investor sentiment.

Therefore, defensive shares such as BAT (LON:BATS) and GSK (LON:GSK) may be relatively attractive investment opportunities. Both companies offer high yields, are less influenced by the short-term economic picture than many of their FTSE 100 peers, and seem to have long-term growth strategies that could lift their stock prices.

Defensive appeal

Cigarette volumes have experienced a sustained fall in the past few years as tobacco products have become less popular in many key markets. Despite this ongoing risk, BAT’s financial performance has been robust this year. Its pricing power has adequately offset reduced demand for cigarettes.

This helped the company to meet its half-year guidance, while it is on track to deliver financial performance that is in line with expectations for the full year.

GSK also stated that it is on target to meet full-year earnings guidance in its latest half-year results. It reported promising data for pipeline drugs to treat HIV and Oncology. Further encouraging news in this area could lift its appeal among investors while many FTSE 100 stocks are struggling to report positive news.

Its vaccines business has experienced disruption this year as a result of Covid-19 challenges. They may persist in the short run and represent a risk to its financial outlook. However, the company’s underlying performance has continued to be relatively robust.

Income prospects

The two companies are on track to afford their forecast dividend payments for the current year after their recent positive financial performances.

BAT has a prospective dividend yield of around 8%. It is also expected to grow dividends per share by 6% next year. With only 65% of its earnings being paid out as a dividend, its shareholder payments seem to be resilient. This could enhance its appeal in a period where low interest rates are likely to be the norm.

GSK’s dividend yield of 5.4% is attractive in an era when many FTSE 100 shares have rebased their shareholder payments. It is due to be covered 1.5x by net profit this year, which suggests it is easily affordable at the company’s current level of net profit. Although the firm’s dividend payments have failed to rise in recent years on a per share basis, GSK’s large dividend cover suggests there is scope for this to change.

Future prospects

BAT’s long-term growth strategy focuses on non-combustible products such as heated tobacco and e-cigarettes. They now make up 10% of its sales, with the firm forecasting 50 million non-combustibles customers within the next decade.

In the meantime, its tobacco business has the diversity and resilience to produce further earnings growth even in a tough economic climate. Its price-earnings ratio of 8 does not reflect its mix of income appeal, defensive credentials and long-term growth potential in my opinion.

Likewise, GSK is making major changes to its business model. It is going ahead with plans to split into two separate entities. One will focus on consumer healthcare, while the other will be a pharmaceutical-focused business. This should lead to operating efficiencies from 2022 onwards that more than offset the cost of separation.

The firm’s price-earnings ratio of 12 seems to include a discount for the changes it is making, in my view. This could signal increased investment appeal, with its income and defensive qualities helping to differentiate it from most FTSE 100 stocks during a very challenging period for the British economy.