Don't let US tobacco woes cloud the attraction of cheap UK stocks

Monsoon soaks up benefits of new ranges; White Young Green's shares deserve to be higher

For once it wasn't smoke in their lungs that set investors in tobacco stocks choking last week. The move by Philip Morris, the US cigarette king, to slash its earnings forecast left shareholders in its UK rivals, British American Tobacco, Imperial and Gallaher, gasping for a fag to calm their nerves.

But a closer look at the three groups, who have towered above their FTSE peers amid this year's stock market turmoil, reaffirms their strong defensive qualities and shows that it isn't too late for new investors to share in the spoils.

Of the three, only BAT has a US business, which makes it the only one to be directly affected by the heady competition hitting Philip Morris and RJ Reynolds. At issue is the soaring price gap between a cheap smoke in the US and the likes of Marlboro, which has forced the two US companies to ramp up their promotional spending on premium cigarettes to boost market share. The good news for the UK boys is that this problem is US specific. While analysts at JP Morgan expect BAT to lower its earnings expectations, the US accounts for just 13 per cent of its earnings and most of this comes from lower priced brands such as Pall Mall. Moreover, the market has already priced in any downgrade so, all in all, the group is still sitting pretty.

Although the sector has outperformed, historically shares in all three tobacco groups still look inexpensive. Factor in their chunky dividend yields, low-risk earnings and strong track records and all three look tempting.

BAT just stands out, however, on both a valuation and yield reckoning. On a price/earnings ratio, the group trades at 9.2 times against Gallaher's 11 times and Imperial's 11.4. And it yields 5.8 per cent to Gallaher's 4.8 per cent and Imperial's 4.3 per cent. BAT may trail in terms of compound annual earnings growth over the next three years – particularly to Imperial, which recently splashed out to acquire Germany's Reemtsma – but it is on the prowl for an acquisition and has plenty of cash to spend. BAT shares, which closed at 640p yesterday, are well off their year high of 819p and now could be a good time to buy.

Monsoon soaks up benefits of new ranges

The women's fashion chain Monsoon has hit on a formula that not only seems to be as popular as ever with shoppers but which also works overseas.

Trading at its flagship women's clothing chain and the Accessorize outlets, which specialise in selling hats, scarves and jewellery, has been in line with expectations and the company remains "confident". Sales in the 18 weeks to 28 September were up 10 per cent but like-for-like sales were down 1 per cent, the chairman, Peter Simon, told the company's annual general meeting yesterday.

That can hardly be described as booming but would have been impacted by the company's decision to delay markdowns over the summer in favour of improving margins. And that strategy looks to have paid off. As predicted, Monsoon has managed an "improved profits performance" in the first quarter of the year.

Life has improved since. Sales in the five weeks since mid-August were up 12 per cent, or up 3 per cent on a like-for-like basis. The successful launches of its Monsoon Baby range as well as its Accessorize Angels range – selling accessories to children under 11 – have, no doubt, helped. International sales and profits from the group's portfolio of about 70 franchised stores overseas also grew "well", the company said.

And Monsoon has a strong balance sheet, including some £32m cash (as at the end of May), to support more organic growth in the UK and overseas. Analysts predict the company will make a pre-tax profit of £34m to £35m in the current year, translating to earnings of around 13.4p a share. That puts the stock, unchanged last night at 114.5p, on a forward multiple of 8.5 times which when compared with New Look, trading at around 11.8 times, or Ted Baker, trading at around 11 times, does not seem demanding.

The shares have had a decent rally over the past two months but remain well beneath this spring's 143.5p high. Assuming consumer spending remains reasonable in the run-up to Christmas, the stock looks attractive.

White Young Green's shares deserve to be higher

White Young Green are consulting engineers that have branched out into other types of work, such as project management and environmental services.

Reporting full-year results yesterday, the company was keen to distance itself from the troubles that are very apparent at contractors, such as Amey and WS Atkins.

The company is a hired gun as a consultant on projects. It puts up no equity for deals, has no bid costs and bears no contracting risk. Its workers are white collar and do not get their hands dirty digging things up and building structures. They are advisers and their margins, at 9 per cent, are twice as good as the contractors they work for.

Some 50 per cent of revenues is from the public sector (14 per cent from the Private Finance Initiative), which is a very safe source of sales these days. WYG misses out on the long-term revenue streams from PFI contracts and the upside from them, but it does not bear the sort of risk that has seen many contractors come unstuck.

The company reported a 21 per cent rise to £4.9m in pre-tax profits for the year ended 30 June, adjusted for goodwill and property profits. Following a period (post 11 September) when customers were putting off decisions on new business, the order book is looking very healthy. The stock closed at 116.5p yesterday, up 1.5p, putting it on a forward multiple of 8, which is similar to a rating for contractors but, given the lower risks at White Young Green, the shares deserve to be rated higher.