Stellar piece. While tobacco companies are outside our competence (we're instead focused on a similar setup in coal companies), we've fully enjoyed following your work in the sector. Keep up the great work!
Essentially, looking at capital returns via share repurchases and dividends based on fcf conversion, and acting (what I hope to be) beyond conservatively when thinking about inevitable future M&A.
I agree with Breely, this is such a complete article!
You covered the history of cigars, the (challenging) manufacturing process of premium cigars, US regulation, and STG’s own history and financial performance. As I was reading I wrote down questions I was planning to ask, only to find out you had answered them later in the article!
We are so used to seeing declining cigarette volumes that the first chart is an eye opener to me.
It should be noted that cigars, both premium and machine-made, do have structural decline rates. It's been somewhat masked by cyclicality having historically led to upswings. Overall, the decline rate is low-single digit, so pricing has easily offset, plus, for STG specifically, taking share has kept volumes fairly robust - though they don't specific disclose exact volume compositions.
I hold a few shares. I m from Europe so i mostly know their machine made brands. You get them at every gas station in Germany.
This market is very consildated between a few players. It s hard to say what the growth prospects are. Scandinavian has made a very good job so far with takeovers + the major shareholders seem to be long time orientated (both foundations have their roots in the tobacco business).
I'm glad you enjoyed the piece. Thanks for commenting!
There is unlikely to be volume growth for machine-made in Europe. However, the consolidated nature of the industry allows for fairly rational price take, which may very well allow value to grow - or perhaps decline only modestly - over time for the segment.
Yes. The US cigar market is the main thing, but as you showed with Agio , there could be more opportunities to buy dirt cheap european assets.
I wonder if they could have growth with sales in Asia. Davidoff (big swiss cigar company) has a lot of growth there. The company did a good job since the IPO 2015 so far. Scandinavian foundations (main owners) are often very long-term oriented.
I didn't know the name, and it's very interesting.
With such brands and expertise in cigars, it would make sens for STG to develop in emerging markets, especially in Asia. I think it makes more sense than experimenting NGPs.
Do you have any idea why they stay only in the US and Europe, even if they can't find growth there ?
I agree that expanding with its core competency makes far more sense than NGP experiments - thankfully those experiments have been quite small so far. The key issue is that it remains effectively impossible to build a true presence in either China or India with premium cigars. US remains the most lucrative market for prem, while machine made in EU continues to be a cash cow that resembles dynamics more similar to cigarettes, albeit with lower vol declines. I think it's most likely we see continued small acquisitions of 2-3 per years to further build their portfolio of prem in US, along with modest super store growth each year. I don't think the company needs to focus on markets that it is less established in when there are such clear growth levers in the lucrative markets it already succeeds in. Thanks for commenting!
Really enjoyed this writeup. It's likely that more acquisition opportunities will arise on the cigar side as demand and pricing return to more "normal" post-Covid levels. And maybe I'm just projecting, but I think there's upside optionality on the pipe tobacco side as well.
Really enjoy reading the tabacco series. Could you please clarify what you mean when you say the model assumes 100% of fcf is returned to shareholders but at the same time say your model is FCF ex acquisitions? What are you reserving for acquisitions? Annually?
Glad you've enjoyed my work, Brian. Sorry if that portion of the valuation was not straightforward. The model is calculating the rate at which EBITDA converts to FCFE based on the company's historic average. Historically, the company has engaged in quite a few acquisitions, so the resulting conversion rate is lower than if you were to calculate the rate at which EBITDA converted to FCFE before acquisitions. I don't want to pretend I can forecast the types of deals the company will do in the future, though it does seem likely that more acquisitions will occur, but we can't say with certainty. All else equal, this means that the outcome would differ from the model materially in one of two ways:
1. If the company engages in acquisitions at the same rate, FCF conversion will be in-line with the historic average, which is the rate that the model uses. However, this model is not illustrating any contribution from acquisitions, which means EBITDA would be higher than what is shown.
2. If the company does not engage in acquisitions at the same rate, it will have a substantially higher rate of EBITDA converting to FCF, therefor substantially higher dividends and share repurchases, if all else is equal.
Regardless of how reality unfolds, it will look much different than the model. This approach isn't meant to be precise or predictive. It's attempting to identify a considerable margin of safety. To help clear this up, I'll attempt to illustrate ideas around the company's valuation using different approaches in future pieces. Thanks for commenting.
Incredible, best analysis in a long time
Thank you Victor! Glad to know you've found it valuable.
Stellar piece. While tobacco companies are outside our competence (we're instead focused on a similar setup in coal companies), we've fully enjoyed following your work in the sector. Keep up the great work!
Thanks, SB. Truly appreciated. And likewise, you're content is great, but much of it is outside my wheelhouse.
But hey, a little expanding of the circle of competence never hurt anyone! So we continue to read.
Really enjoyed reading! A great and thorough analysis of an interesting industry niche and company that doesn’t get much coverage!
Thanks for reading, Breeley. Glad you enjoyed it.
Hey, great write-up I just have a question regarding the IRR, can you explain how did you calculate it? Thanks and keep up the good work
Essentially, looking at capital returns via share repurchases and dividends based on fcf conversion, and acting (what I hope to be) beyond conservatively when thinking about inevitable future M&A.
I agree with Breely, this is such a complete article!
You covered the history of cigars, the (challenging) manufacturing process of premium cigars, US regulation, and STG’s own history and financial performance. As I was reading I wrote down questions I was planning to ask, only to find out you had answered them later in the article!
We are so used to seeing declining cigarette volumes that the first chart is an eye opener to me.
It should be noted that cigars, both premium and machine-made, do have structural decline rates. It's been somewhat masked by cyclicality having historically led to upswings. Overall, the decline rate is low-single digit, so pricing has easily offset, plus, for STG specifically, taking share has kept volumes fairly robust - though they don't specific disclose exact volume compositions.
Thank you for the clarification!
Thanks. Makes me want to start smoking :) I’ll stick this one on onto my watch list, It will be my first Danish stock.
Assuming you are an adult, you should be able to if you wish! Glad you enjoyed the piece.
Hey good writeup :).
I hold a few shares. I m from Europe so i mostly know their machine made brands. You get them at every gas station in Germany.
This market is very consildated between a few players. It s hard to say what the growth prospects are. Scandinavian has made a very good job so far with takeovers + the major shareholders seem to be long time orientated (both foundations have their roots in the tobacco business).
Greetings Ulrich
I'm glad you enjoyed the piece. Thanks for commenting!
There is unlikely to be volume growth for machine-made in Europe. However, the consolidated nature of the industry allows for fairly rational price take, which may very well allow value to grow - or perhaps decline only modestly - over time for the segment.
Yes. The US cigar market is the main thing, but as you showed with Agio , there could be more opportunities to buy dirt cheap european assets.
I wonder if they could have growth with sales in Asia. Davidoff (big swiss cigar company) has a lot of growth there. The company did a good job since the IPO 2015 so far. Scandinavian foundations (main owners) are often very long-term oriented.
Davidoff is very impressive in the ultra-premium handmade space. And I agree - the management team is strong and I appreciate their long-term focus.
Hi,
Thank you very much for this analysis.
I didn't know the name, and it's very interesting.
With such brands and expertise in cigars, it would make sens for STG to develop in emerging markets, especially in Asia. I think it makes more sense than experimenting NGPs.
Do you have any idea why they stay only in the US and Europe, even if they can't find growth there ?
I agree that expanding with its core competency makes far more sense than NGP experiments - thankfully those experiments have been quite small so far. The key issue is that it remains effectively impossible to build a true presence in either China or India with premium cigars. US remains the most lucrative market for prem, while machine made in EU continues to be a cash cow that resembles dynamics more similar to cigarettes, albeit with lower vol declines. I think it's most likely we see continued small acquisitions of 2-3 per years to further build their portfolio of prem in US, along with modest super store growth each year. I don't think the company needs to focus on markets that it is less established in when there are such clear growth levers in the lucrative markets it already succeeds in. Thanks for commenting!
Curious if you be writing an update on the disappointing Q2 report?
Yes! Will definitely be producing many follow-ups moving forward. Thanks for your interest, Jarrod.
Really enjoyed this writeup. It's likely that more acquisition opportunities will arise on the cigar side as demand and pricing return to more "normal" post-Covid levels. And maybe I'm just projecting, but I think there's upside optionality on the pipe tobacco side as well.
I fully agree! Pipe tobacco is another category that remains less-than-an-afterthought.
Really enjoy reading the tabacco series. Could you please clarify what you mean when you say the model assumes 100% of fcf is returned to shareholders but at the same time say your model is FCF ex acquisitions? What are you reserving for acquisitions? Annually?
Glad you've enjoyed my work, Brian. Sorry if that portion of the valuation was not straightforward. The model is calculating the rate at which EBITDA converts to FCFE based on the company's historic average. Historically, the company has engaged in quite a few acquisitions, so the resulting conversion rate is lower than if you were to calculate the rate at which EBITDA converted to FCFE before acquisitions. I don't want to pretend I can forecast the types of deals the company will do in the future, though it does seem likely that more acquisitions will occur, but we can't say with certainty. All else equal, this means that the outcome would differ from the model materially in one of two ways:
1. If the company engages in acquisitions at the same rate, FCF conversion will be in-line with the historic average, which is the rate that the model uses. However, this model is not illustrating any contribution from acquisitions, which means EBITDA would be higher than what is shown.
2. If the company does not engage in acquisitions at the same rate, it will have a substantially higher rate of EBITDA converting to FCF, therefor substantially higher dividends and share repurchases, if all else is equal.
Regardless of how reality unfolds, it will look much different than the model. This approach isn't meant to be precise or predictive. It's attempting to identify a considerable margin of safety. To help clear this up, I'll attempt to illustrate ideas around the company's valuation using different approaches in future pieces. Thanks for commenting.
Thanks for the thoughtful reply. Makes sense and 100% agree w.r.t being precisely wrong vs approximately right. Look forward to future posts!