The Nicotine Anti-Bubble
“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” - Winston Churchill
One of the great things about studying any specific industry is that you will inevitably cross paths with others who share the same unyielding interest. Recently, alongside my co-hosts Douglas Ott and Lawrence Hamtil, I had the privilege of talking with Rae Maile on the Preferred Shares Podcast. Rae is currently the Managing Director of Research at Panmure Liberum and holds the distinction of covering the tobacco industry for more than 35 years—longer than any other current analyst. His tenure has provided him with an unmatched perspective on the industry’s evolution, and he maintains strong views and is always eager to support them with equally strong data:
While all aspects of the industry were far too vast to explore in just over an hour, our conversation covered tremendous ground, and one point, in particular, is worth highlighting: Why has the tobacco industry excelled? Why does it stand uniquely as an industry that never posted a negative ten-year return at any point in the last century?
It may be instinctive to point to margins, capital lightness, or any number of virtuous business qualities that tobacco has in spades. But they are an incomplete explanation. Think of the last one hundred years. Competition, regulation, and litigation paced alongside feast and famine, boom and bust, war, and other monumental geopolitical events. Through it all, one attribute has sustained:
Pessimism
Rae stated:
Everyone is convinced it’s all over tomorrow. And to be fair, that’s pretty much what the industry has been telling everyone since the 1950s, too. So there’s a good reason why everyone else would believe it.
The source of pessimism is rooted in one core misunderstanding, as Rae later elaborated:
Everyone believes it’s not going to last. And so what people have consistently got wrong in all of their assessments of value has been the longevity, for want of a better term, the sustainability of the business model. People have misread that point about smokers wanting to smoke still. No matter how you change the regulation, people... There’s a guy in the States, he hasn’t been so active recently, a guy called Carl Phillips, who coined the phrase ‘demonic possession.’ He said, when it comes to looking at the personal economics of tobacco, it’s the only product we ever look at where we have to suspend all rational economic arguments. Normally, we assume people buy things because they get enjoyment from doing so. Not with tobacco. We are not allowed to believe that of tobacco. We can only believe in demonic possession—that smokers gain no utility whatsoever from their consumption. And I think that’s probably what really lies at the heart of it. Ultimately, everyone’s convinced there’s no reason to smoke and you couldn’t possibly and therefore everyone will stop. And in actual fact, smokers go, “Well, do you know what? There’s a trade-off I always make in my life and crossing the road has a risk. So actually I enjoy smoking. It helps me. I get pleasure from it and therefore I’ll pay for it.”
Surely, the last century can’t be used as a blueprint to explain the unfolding of the next. Few believe in the longevity of legacy products, and broadly, barriers to entry for new product categories are lower, fostering a degree of new competition. The extent of continued product innovation is unknown, and questions linger on the exact degrees of brand loyalty, usage curves, and so on. Also, consider that anti-smoking groups have transitioned to anti-nicotine and continually attempt to tie up the industry—with certain regulatory bodies happy to oblige. In addition, ESG-driven investing has dramatically reduced the number of buyers while bolstering waves of sellers, and Brexit and other geopolitical events have further reduced interest. Yet, here sits an industry with a small set of publicly traded firms sporting supernormal profitability and tremendous capital returns, trading at an aggregate multiple far under the broad market as total demand for recreational nicotine remains robust. It is a royalty on human pleasure that will continue to be overlooked so long as the simple fact that nicotine is pleasurable remains widely disregarded.
So long as widespread pessimism persists, so can opportunity.
…the fundamental idea of anti-bubbles is widely applicable. The attention, optimism, and capital required to inflate an asset must be sourced. At any given time, there must also be assets, industries, or companies, unduly depressed - the extent of which can vary just as much as the duration. The driver could be sudden and acute, leading to a low point in weeks or months. The largest anti-bubbles continue for years or decades, driven by structural pessimism.
Maximum dismay is often met with minimum price. When no one else wants to own something, you can generally purchase it for a ridiculous price far under intrinsic value. But the concern is that there is no clear way to measure maximum dismay precisely. Awkwardly, and by definition, maximum dismay shouldn’t be reached until your own expectations collapse. Even when you’re right, it can look like you’re heading into a black hole.
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Ownership Disclaimer
I own positions in tobacco companies such as Altria, Philip Morris International, British American Tobacco, Scandinavian Tobacco Group, and Imperial Brands. I also own positions in Haypp Group, a major online retailer of reduced-risk nicotine products.
Disclaimer
This publication’s content is for entertainment and educational purposes only. I am not a licensed investment professional. Nothing produced under the Invariant brand should be thought of as investment advice. Do your own research. All content is subject to interpretation.
Coincidentally, on Friday Nikkei published an interview with Japan Tobacco, which has recently acquired Vector Group (who only sells cigarettes):
Q: Over 90% of JT's tobacco revenue comes from cigarettes. Do you see sales continuing to grow?
A: We expect 60% or more of revenue to come from cigarettes even in 2035.
Rae is onto something when he says most of us are unable to understand why someone would want to pay for cigarettes. In 2020, when I was first looking into tobacco stocks, I asked myself what edge I had, why the market might be offering an opportunity. I wrote down: “Financial professionals and investors are mostly top 20%/1%; few smoke.” I work in technology and almost no one around me (most of whom hold graduate degrees) smoke. It’s difficult to put ourselves into the shoes of people who are more likely smoke, like service industry workers such as cooks and estheticians.