Living in Germany i have another view on BAT and the industry. I know that cigarettes are down a lot in the last year in the United States.
Here in Germany Vuse is going strong. It's often the only vape brand in supermarkets. They are in the gas stations etc.. Velo is doing strong and seems to be a market leader in the pouch sector ( outsite the US).
The valuation of the stock discounts all the positive outcomes like growth in alternatives, much highter smoking rates in other parts and the world and the growing markets in Asia.
Smoking is down in the US, yes. But i think the worldwide picture differs a lot. Yes , the US is the most profitable market, but i think at these valuations it s difficult to loose with a global tobacco stock.
Thanks for your input, Ulrich. I very much agree. There is quite a bit of segment data pointing to BAT succeeding across a number of geographies and categories. In aggregate, there is quite a lot to like about the execution. Following FY numbers, I'll be sure to explore them in more detail, as I have in the past.
First, many thanks Devin for your coverage of the Tobacco industry! You're by far the best analyst in the space and I'm very happy you offer your insights for free to the public.
As to the write-down, I do not take it lightly. Because it means that BAT in 2017 overpaid by 25 Billion, a sum that is now written down to zero. That is roughly double the sum that Altria deployed in its JUUL acquisition fiasco. Altria's capital allocation skills regarding the JUUL deal are presented now as catastrophic, and if one concurs with this judgement (though I know you don't), the Reynold's acquisition, for the fact that BAT by its own admission overpaid by 25 Bio, should be seen as more catastrophic still. And while the write-down is non-cash, the original deal in 2017 was both in cash and equity and its ripple effects will be felt for many years to come. First, by diulting shareholders with the issued equity; second, by loading the company with debt, which impairs the company's investment agility and its ability to return capital to shareholders (buybacks, more substantial dividend increases).
So in my view, it's more than justified that the stock price took a beating. There is a fundamental reasoning behind this and it cannot just be attributed to sentiment.
I wholly agree with your assessment that management has its priorities right with focusing on investment and deleveraging instead of buybacks. As far as I'm concerned, they could go much farther down the deleveraging road, as a continued suspension of buybacks would hopefully keep the stock price at depressed levels and thus provide for good buying opportunities.
"So in my view, it's more than justified that the stock price took a beating."
In fact, I wholly agree, in that the stock has taken a beating since the deal took place. I did not own either BAT or Reynolds prior to the deal occurring; having long preferred other names. However, what I hoped to express in this piece was that the severity of the overpayment was already more than baked in to the price of the current equity. Therefor, I do not think that the write-down was the major point of concern, although it is very good for headlines. As for capital allocation more recently, we are also in full agreement that management has been prudent. There will be plenty of time for share repurchases in the future so long as pessimism remains widespread. Thanks for your thoughts and kind words, Simon!
Write-downs of this nature do not affect taxes until the related asset is disposed of. The company will begin amortization of the remaining value of its U.S. combustible brands starting next year. For IFRS standards regarding the treatment of intangibles, you may find this useful:
Great article. It was interesting to learn on the call that HNB is the money losing new category. I think the non-tobacco disposables they announced could also be a game changer for glo.
EV/EVITDA is even lower imo, given Tadeau all but confirmed he will be trying to liquidate some of the ITC stake
Thanks. Very helpful. I’d expect that claimants wouldn’t rate their chances of piercing the veil and that a settlement will reflect that. Yes, slightly odd that the company hasn’t itself deconsolidated Canada reporting, unlike PM.
The reporting provided by both companies leaves considerable holes that investors would much preferred filled. As is always the case, transparency should be a priority of the highest order.
That's a great question, Shobba. From my perspective, related operations can be conservatively discounted when thinking about the company moving forward. From a valuation perspective, the impact is more than offset by similar conservative actions such as how to account for the the loss of Russian operations. The Canada litigation is largely isolated, and does not appear to post a risk to the company as a whole. Credit rating issuers have also specifically flagged the impact of these effects, highlighting a difference between how they are calculating profitability and leverage ratios vs. how the company is presenting such information.
Thanks for your great write up Devin! If BAT fired on all cylinders in an alternate universe with U.S. combustible business gaining shares, vaping business without disruption from Chinese disposable vapes, heated tobacco business taking shares from IQOS, Velo 2 approved by FDA and taking shares from ZYN, ITC Ltd shares available for sale...... then its valuation wouldn't be trading at its current level. Strong corporations usually make costly mistakes and implode when everything is going their way, while extremely cautious when facing multiple headwinds since there's no margin of error. If investors prefer to invest in tobacco stocks in perfect weather, think about 2015-2017 and bon voyage :)
Thanks, Anthony. Interesting point made, and I think you are spot on. Many investors want to seek out companies they view as being completely unassailable. I myself hold a handful - the issue is that acquiring shares in such companies rarely comes at a lofty price, and paying a premium price, as you touched on, offers little wiggle room for when it is realized all companies face challenges, one way or another, eventually - the view that something is unassailable is often an illusion. Conversely, as you also touched on, companies facing a stack of challenges often appear to have little wiggle room as to execution. But when companies trade at what appear to be significantly depressed multiples, there is quite a bit of leeway as to what performance is necessary to generate an excess return. At its heart, this is the dance of calculating a margin of safety.
Thank you very much for writing this Devin! When I read the announcement I was hoping you’d comment on it!
I agree with Simon that your coverage of the tobacco industry is exceptional.
> I have long argued that relative to peers, British American Tobacco faces the widest spectrum of potential future outcomes.
One could make the argument that the market is not pricing in any positive outcomes. The stock is now trading at about 6.5x EV to adj EBITDA, which is the lowest since 2002-3, and much lower than the >15x over 2015-7.
As investors, we need to figure out what our edge is. The markets are pretty efficient -- why would I be able to beat them? In this case, (a) as you put it this is an unloved industry / company / country and the stock can’t count on a rerate, and (b) there are no obvious short term “catalysts” like stock buybacks or FDA enforcement against disposable vapes. In other words, investors can expect a lot of pain.
I am all for pain - it's part of the process. Investing, at its core, is about deploying capital responsibly, weighing risks, and gauging the odds of over/underperformance relative to expectations baked in to an asset. Simply, I view BAT as priced for free cash to rapidly degrade, and I think that is far from the case. So long as management acts responsibly, I am content to be patient and allow such cash flows to find their way into my pocket; a total present value far above my entry cost. I am also happy to concede the looming uncertainty surrounding the company and industry - which speaks to the 'basket approach' tucked into a broader portfolio. There are always limitations, and capital preservation is paramount. Further, conviction can never be borrowed or lent, and everyone must do their own math, research, etc.
Thanks as always, Tian. I greatly appreciate you taking the time to respond to my work.
Good Article as always.
Living in Germany i have another view on BAT and the industry. I know that cigarettes are down a lot in the last year in the United States.
Here in Germany Vuse is going strong. It's often the only vape brand in supermarkets. They are in the gas stations etc.. Velo is doing strong and seems to be a market leader in the pouch sector ( outsite the US).
The valuation of the stock discounts all the positive outcomes like growth in alternatives, much highter smoking rates in other parts and the world and the growing markets in Asia.
Smoking is down in the US, yes. But i think the worldwide picture differs a lot. Yes , the US is the most profitable market, but i think at these valuations it s difficult to loose with a global tobacco stock.
Greetings Ulrich
Thanks for your input, Ulrich. I very much agree. There is quite a bit of segment data pointing to BAT succeeding across a number of geographies and categories. In aggregate, there is quite a lot to like about the execution. Following FY numbers, I'll be sure to explore them in more detail, as I have in the past.
First, many thanks Devin for your coverage of the Tobacco industry! You're by far the best analyst in the space and I'm very happy you offer your insights for free to the public.
As to the write-down, I do not take it lightly. Because it means that BAT in 2017 overpaid by 25 Billion, a sum that is now written down to zero. That is roughly double the sum that Altria deployed in its JUUL acquisition fiasco. Altria's capital allocation skills regarding the JUUL deal are presented now as catastrophic, and if one concurs with this judgement (though I know you don't), the Reynold's acquisition, for the fact that BAT by its own admission overpaid by 25 Bio, should be seen as more catastrophic still. And while the write-down is non-cash, the original deal in 2017 was both in cash and equity and its ripple effects will be felt for many years to come. First, by diulting shareholders with the issued equity; second, by loading the company with debt, which impairs the company's investment agility and its ability to return capital to shareholders (buybacks, more substantial dividend increases).
So in my view, it's more than justified that the stock price took a beating. There is a fundamental reasoning behind this and it cannot just be attributed to sentiment.
I wholly agree with your assessment that management has its priorities right with focusing on investment and deleveraging instead of buybacks. As far as I'm concerned, they could go much farther down the deleveraging road, as a continued suspension of buybacks would hopefully keep the stock price at depressed levels and thus provide for good buying opportunities.
"So in my view, it's more than justified that the stock price took a beating."
In fact, I wholly agree, in that the stock has taken a beating since the deal took place. I did not own either BAT or Reynolds prior to the deal occurring; having long preferred other names. However, what I hoped to express in this piece was that the severity of the overpayment was already more than baked in to the price of the current equity. Therefor, I do not think that the write-down was the major point of concern, although it is very good for headlines. As for capital allocation more recently, we are also in full agreement that management has been prudent. There will be plenty of time for share repurchases in the future so long as pessimism remains widespread. Thanks for your thoughts and kind words, Simon!
Thank you very much Devin. Delivering your work for free is awesome. The quality of your reports is unbeatable!
Thank you for the kind words, Ruediger. The support of readers, including all feedback and criticisms, has been deeply appreciated.
The Tobacco Reporter! Thanks Devin! :)
Thanks, Pat!
Does any one know if this Twenty-five billion writedown will have impact on BAT tax obligations?
Write-downs of this nature do not affect taxes until the related asset is disposed of. The company will begin amortization of the remaining value of its U.S. combustible brands starting next year. For IFRS standards regarding the treatment of intangibles, you may find this useful:
https://www.ifrs.org/issued-standards/list-of-standards/ias-38-intangible-assets/#about
I was actually wondering about the same thing. Given that this is related to their US sub, I presume they can only shield US earnings.
If anyone with genuine expertise could provide some insights, I'd greatly appreciate it.
Yes I have the same question. If they sell their ITC stake, can they offset capital gains taxes?
Great article. It was interesting to learn on the call that HNB is the money losing new category. I think the non-tobacco disposables they announced could also be a game changer for glo.
EV/EVITDA is even lower imo, given Tadeau all but confirmed he will be trying to liquidate some of the ITC stake
Consumables* not disposables
Thanks. Very helpful. I’d expect that claimants wouldn’t rate their chances of piercing the veil and that a settlement will reflect that. Yes, slightly odd that the company hasn’t itself deconsolidated Canada reporting, unlike PM.
The reporting provided by both companies leaves considerable holes that investors would much preferred filled. As is always the case, transparency should be a priority of the highest order.
Hi Devin - how should we think about exposure ranges for the Canada litigation?
Is there a remote sink-the-company type risk?
That's a great question, Shobba. From my perspective, related operations can be conservatively discounted when thinking about the company moving forward. From a valuation perspective, the impact is more than offset by similar conservative actions such as how to account for the the loss of Russian operations. The Canada litigation is largely isolated, and does not appear to post a risk to the company as a whole. Credit rating issuers have also specifically flagged the impact of these effects, highlighting a difference between how they are calculating profitability and leverage ratios vs. how the company is presenting such information.
Thanks for your great write up Devin! If BAT fired on all cylinders in an alternate universe with U.S. combustible business gaining shares, vaping business without disruption from Chinese disposable vapes, heated tobacco business taking shares from IQOS, Velo 2 approved by FDA and taking shares from ZYN, ITC Ltd shares available for sale...... then its valuation wouldn't be trading at its current level. Strong corporations usually make costly mistakes and implode when everything is going their way, while extremely cautious when facing multiple headwinds since there's no margin of error. If investors prefer to invest in tobacco stocks in perfect weather, think about 2015-2017 and bon voyage :)
Thanks, Anthony. Interesting point made, and I think you are spot on. Many investors want to seek out companies they view as being completely unassailable. I myself hold a handful - the issue is that acquiring shares in such companies rarely comes at a lofty price, and paying a premium price, as you touched on, offers little wiggle room for when it is realized all companies face challenges, one way or another, eventually - the view that something is unassailable is often an illusion. Conversely, as you also touched on, companies facing a stack of challenges often appear to have little wiggle room as to execution. But when companies trade at what appear to be significantly depressed multiples, there is quite a bit of leeway as to what performance is necessary to generate an excess return. At its heart, this is the dance of calculating a margin of safety.
Thank you very much for writing this Devin! When I read the announcement I was hoping you’d comment on it!
I agree with Simon that your coverage of the tobacco industry is exceptional.
> I have long argued that relative to peers, British American Tobacco faces the widest spectrum of potential future outcomes.
One could make the argument that the market is not pricing in any positive outcomes. The stock is now trading at about 6.5x EV to adj EBITDA, which is the lowest since 2002-3, and much lower than the >15x over 2015-7.
As investors, we need to figure out what our edge is. The markets are pretty efficient -- why would I be able to beat them? In this case, (a) as you put it this is an unloved industry / company / country and the stock can’t count on a rerate, and (b) there are no obvious short term “catalysts” like stock buybacks or FDA enforcement against disposable vapes. In other words, investors can expect a lot of pain.
I am all for pain - it's part of the process. Investing, at its core, is about deploying capital responsibly, weighing risks, and gauging the odds of over/underperformance relative to expectations baked in to an asset. Simply, I view BAT as priced for free cash to rapidly degrade, and I think that is far from the case. So long as management acts responsibly, I am content to be patient and allow such cash flows to find their way into my pocket; a total present value far above my entry cost. I am also happy to concede the looming uncertainty surrounding the company and industry - which speaks to the 'basket approach' tucked into a broader portfolio. There are always limitations, and capital preservation is paramount. Further, conviction can never be borrowed or lent, and everyone must do their own math, research, etc.
Thanks as always, Tian. I greatly appreciate you taking the time to respond to my work.
How you are not tired to write about tobacco is beyond me, but great writing as always!
The past, present, and potential futures of the industry always keep my mind busy. I simply find it all fascinating. Thanks YZ!