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BTI - British American Tobacco


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I recently wrote-up a brief thesis on British American Tobacco in the first edition of The Elevator Pitch.  I think it can be a double over the next three years, and it's particularly nice to own something recession-resistant in a time like this.  I'd be interested to hear your thoughts.

 

Link: https://elevatorpitch.substack.com/p/-cigarettes-and-student-loans-

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  • 3 months later...

So it looks like BTI is back to a ~8% dividend yield. Has anybody any idea why this has underperformed compared to PM (it’s closest peer)?

What I read seems to indicate that PM’s IQOS next gen smoker seem to do better in some countries (Japan) than BTI’s Systems (they seems to have 2 at least) so perhaps Mr Market thinks that PM/ MO will gain market share going forward. I do think that 10 years from now, the most common nicotine delivery method will move beyond the archaic smoking to a large extend. BTI should be in the game somehow, but the future may not look like the past.

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So it looks like BTI is back to a ~8% dividend yield. Has anybody any idea why this has underperformed compared to PM (it’s closest peer)?

 

Maybe because they are messing around with things like trying to find a COVID vaccine? No wonder their ROIC and ROE lag PM and MO.

 

 

https://www.marketwatch.com/story/british-american-tobacco-says-its-awaiting-fda-permission-to-start-covid-19-vaccine-trials-2020-07-31

 

 

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So it looks like BTI is back to a ~8% dividend yield. Has anybody any idea why this has underperformed compared to PM (it’s closest peer)?

What I read seems to indicate that PM’s IQOS next gen smoker seem to do better in some countries (Japan) than BTI’s Systems (they seems to have 2 at least) so perhaps Mr Market thinks that PM/ MO will gain market share going forward. I do think that 10 years from now, the most common nicotine delivery method will move beyond the archaic smoking to a large extend. BTI should be in the game somehow, but the future may not look like the past.

Well I actually kinda like this one.

 

But first off BATS is not really a PM peer. I think the reason why it has underperformed is that a few years back they bought out the piece of Reynolds that they didn't own (I think around 57%). It turns out that it was a dumb deal and they overpaid (shocker). Well since then they keep taking impairment charges on that. That of course will make the ROE and ROA suck. Also why it's not a PM peer. BATS business right now is about 50% US and 50% rest of world.

 

But the acquisition also made the stock tank. So you can say the stupidity was priced in or over priced in. For 2019 you had the following:

-Net Income of 5.8 bn

-In there was depreciation amortization and impairment of 1.5 billion

-Against that CAPEX was 664 million

-When you work through all of it you get free cash of 6.7 billion

-Oh there's also about 600 million of integration and restructuring charges that's not in the amortization line and you'd think that those will stop at some point

 

2020 also looks like it's coming in line with 2019 but with somewhat less cash due to COVID inventory builds which you'll expect to reverse at some point in the future.

 

The dividend is about 4.7 billion so it's well covered by free cash. So you have 6.7 billion against a 57 billion market cap. I think that's a pretty good deal. At these levels you don't need a lot of things to go right in order to do well.

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The cigarette companies all look attractive (esp. relative to this market) on earnings, FCF, etc. yields. Some more than others, but when the average SP500 company is trading at 20x, 25x earnings, I'd rather buy higher quality @ 11x earnings vs. lower quality @ 9x earnings.

 

It's another way of saying that the market's expectations of future volume declines is (IMO) the biggest reason these appear so cheap.

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The cigarette companies all look attractive (esp. relative to this market) on earnings, FCF, etc. yields. Some more than others, but when the average SP500 company is trading at 20x, 25x earnings, I'd rather buy higher quality @ 11x earnings vs. lower quality @ 9x earnings.

 

It's another way of saying that the market's expectations of future volume declines is (IMO) the biggest reason these appear so cheap.

I don't know about that. Is cigarette volume decline a new thing? No. It's been with these companies for years. So now we have a long history that shows that the cigarette companies do quite ok even with the volume declines. As for the market, they were willing to pay 18 multiples or so a few years back even with volume declines.

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So now we have a long history that shows that the cigarette companies do quite ok even with the volume declines.

Sure but that trend continues until it doesn't, or at least that is my view of the market's perception. Why else are yields so high on these companies? I don't think regulatory risk can account for such wide discounts to the market.

 

As for 18x earnings, I'd attribute that to the market's rosy perception of smokeless products which at the time were the new hype. Obviously that is now muted, at least in the US.

 

Do we have a chart of the average trading P/E range over the past 10,15 years? I think that would be interesting to look at.

 

But I think the main point is investors don't require multiple expansion here. I could understand these companies trading at a constant discount-to-market due to constant threat of losing their pricing power coupled with continued volume declines. But, even in that case you are still doing OK because of the dividend. Heads I win, Tails I don't lose, is how I think of it.

 

And in that case I want to own the company in the industry with the slowest volume declines/premium product.

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I also think the smokers are somewhat of a steal considering the backdrop - it's possible to do quiet well (dividend), possible really good (iQos gains traction, rerating) and possibly relatively great if shit hits the fan. High margins, pricing power, asset light. Recession? Who cases. Inflation? Who cares. Deflation? Who cares.

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Back of the envelope math suggests market at current $33 price discounting 2% or so rev. growth with minimal margin increase over next several years and a 15 times TV multiple, yielding around the curr. div. yield of around 8%. For rates of return above 10%, one has to assume either higher rev. (pricing) or continued higher margins imo.

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  • 9 months later...

Looks like a very good buy regardless. It's a cheap stock with predictable consumer demand. My money has been on Imperial Brands and until recently Altria, but these guys are in the same boat. Big moat, big dividend, 6+X FCF - it's tough to see how you lose money.

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12 hours ago, jemn said:

Little late but what do y'all think about:

https://www.bloomberg.com/news/articles/2021-05-03/secretive-dart-surfaces-with-6-7-billion-bets-on-smoking-giants

I don't think Dart is looking to clip coupons... what do you think his angle is?

The angle is that people won't stop smoking, the stock is cheap as hell and I would say that all the tabacco brands are well positioned to take advantage of continued weed legalisations in the west.

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Posted (edited)

 I am more wondering what capital allocation approach he is suggesting management take. I think he is probably telling them to cut the dividend to buyback stock. considering this would enrage all the dividend crazed investors holding BAT, y'all think management would do this?

Edited by jemn
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Posted (edited)

I also cant think of a way you lose money at these prices. many of the primary concerns I have heard about BAT or tobacco in general are either unrealistic or invalidated by the data. In what realistic situation does BAT not generate 90B pounds in FCF ~80B pounds in FCF over the next 10 years?

Edited by jemn
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Posted (edited)

I am usually all for buybacks, but this situation is an exception in my view: 

1. Capital allocation track record of tobacco stocks is pretty bad (former resident half wit Nic Durante being a case in point). Industry is much more consolidated now, but I am still not sure I trust them with the cash flows. I think the dividends and the debt instill a bit of discipline that I don't think these guys would otherwise have. 

2. One the key benefits of share buybacks over dividends are the tax considerations. Given that there are no dividend withholding taxes in the UK it really depends on the individual tax circumstances of the investor. Assuming you are not taxed on your dividends, I'd rather have BAT pay a dividend. If I like the price, I can buy shares myself. Yes there are frictional costs in doing that in particular the stamp duty, but that seems like a small price to pay to have control over the cashflows. Call it a "free-cash-flow-to-equity-control-premium" + buybacks are not frictionless either in particular the stamp duty would be incurred regardless 

Edited by Cicero
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  • 3 weeks later...

Thought the trading update was very good pretty much in every respect. 5%+ rev growth, +10% new category growth in Q1, market share gains etc. Did not mention heat not burn in the US which means it is probably underwhelming, but that really looks like the only soft spot. Really puzzling that there was basically zero market reaction.  

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I have a position in BTI, with the update with 5% growth, I am considering add a bit more.

 

My main thesis is the following: in a market which is difficult to find bargains, BTI gives 8% dividend distributed across 4 quarters (nice cash cow), some potential multiple expansion, recession resistant and might be an okey hedge if inflation speeds up. 

 

I dont think it is an investment which is going to make extraordinary things, but if someone has some excess cash and wants to put it to work, this seems at least a reasonable idea.

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As a smaller investor it should be possible to find better bargains than in large cap space. But I think some of these hated plays, which ESG investors shy away from, look stupidly valued. And despite generally giving little thought to volatility, their low beta makes BATs and Altria good in downturns, where better bargains are to be had in small caps and it makes sense to rotate. I know these things are hated, but I would argue they are still some of the best businesses in the world and less than half the market mulitple I have some 20 pct in smokes and will probably buy more when I free up some cash.

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As a PM and MO owner I took the plunge on BTI yesterday.

 

Essentially I see these stocks as low beta, low duration equities with a good degree of inflation protection. Not a bad place to hide while much of the world seems to have lost its mind. I'd rather sit in these companies than in cash given the looming inflation threat. 

 

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I prefer MO and took a large bite at 36,5 last year after having sold out in March, when covid hit and it held up better than most of the rest of my portfolio. Now, due to valuation, I prefer BATS, but I'm sticking with MO and has just doubled my expose. I really like MO, because I think the US market is great. Cigarettes aren't very expensive, the political ability to change stuff is close to non-existant, and even if politicians decides they wanna change things it'll probably be held up in litigation for years. With a highly cashflowing and short duration asset that's pretty great although it might suck for the general health.

 

Also, while BATS and PM always emphasize revenue growth, it's usually done in current currency terms, whereas in $ terms their revenue is usually less impressive. With higher inflation in some of their markets, currencies will devalue. I'm sure PM is a fine pick as well, but when the terminal value is a bit unclear (although I'd argue clearer than probably most businesses) I like buying below 10xFCF. I also like how both MO and BATS might be setup for share buybacks in not too long. It's incredible how no one has gone activist and suggested these companies lever up to 5xebitda and tender for their shares, but hopefully that's what Kenneth Dart is doing behind the scenes in BATS.

Edited by kab60
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Personally, I don't think it matters too much. BTI and Imperial are just cheap with larger dividends. Their brands aren't as strong as MO and PM.

All of these guys have huge moats.  You could just see which look cheapest to you - and if you want to pay up for MO/PM. Either way, likely to do fine.

I sold my MO at 50 after the run from 37, but would buy it back in the mid-40's.   You might also include Japan Tobacco as well, although I've never owned it.

Edited by cubsfan
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