For a business where growth prospects are at best smouldering, British American Tobacco (BAT) is suddenly giving its shareholders the kind of kick old smokers would associate with lighting up the first Texan plain of the day.
On the London Stock Exchange, the share price is up more than 20% since the start of the year — a blazing gain that one might associate more with a promising fintech start-up than a business trying to fend off a slow death spiral in its core business.
Reinet, the Rupert family investment company, sold its remaining stake in BAT about six months ago, a move that a good number of market watchers interpreted as a downbeat pronouncement on the future of big tobacco. Well, not so, it seems … though to be honest, I did not walk away from last week’s first half pre-closing update engagement with a huge hankering to snap up a few BAT shares.
It’s still a tough gig, and some of the victories are quite hollow — like beating competitors and holding margin in a market that is in an overall decline.
From what I can observe around me, cigarettes are going the same way as wooden tennis rackets. In tennis terms, there were some diehard adherents, but eventually everyone moved to the comfort and control of oversized graphite rackets.
The proliferation of vapes (and tobacco pouches) tells a story. I rarely see anyone light up. In fact, I hardly notice people vaping, even when it is done under my nose. Vaping certainly seems less offensive, socially speaking.
What does stand out is that the modern tobacco categories offer areas of innovation, just as tennis rackets have evolved from steel to fibreglass and graphite to graphene. I see BAT has now launched glo Hilo, “a new premium device featuring revolutionary TurboStart technology”. Basically this involves introducing a new heating mechanism to a glo electronic smoking device. Whether that’s a game-changer I don’t know.
BAT CEO Tadeu Marroco believes it’s a breakthrough, adding that the pilot market run had seen a 50% increase in new consumers from the previous glo platform. I eagerly await the half-year numbers to gauge just how profitability is being tweaked in BAT’s new category products.
I suppose if there is some justifiable excitement for BAT, a little of this might stem from the recent sale of a portion of its strategic holding in Indian conglomerate ITC, which holds interests in tobacco, hotels, packaging, food, personal care and education.
BAT bagged £1.05bn recently when it sold down its ITC stake. It still holds 22.93%, worth just over £10bn. That represents more than 13% of BAT’s £77.5bn market value.
Aside from bolstering the balance sheet, the proceeds will help support BAT’s share buyback programme — an important initiative in enhancing shareholder returns in a scenario where top-line growth is unlikely to breach double digits in the foreseeable future.
Further ITC sales would, obviously, raise the possibility of special dividends. But that might be wishful thinking. Marroco was quick to scotch any notions of such sales, stressing “it is still for us a strategic investment, not a financial investment”.
I quite like Marroco’s reasoning. It highlights the size of the market in India and the potential GDP per capita growth, as well as the fact that ITC “is a very well-run company and leader in distribution, in tobacco, in cigarettes”.
Perhaps the most interesting bit is that BAT has a multilayer relationship with ITC going back many years. Based on this, the group has an expectation that “new category” can be a big factor in the Indian market in the future. Significantly, BAT is retaining its board representation at ITC.
Speaking of new categories, BAT recently acquired a flavoured disposable vape brand in the US. Though it is relatively small, analysts were understandably keen to press BAT on plans to commercialise the product and to ask about market share targets. The disposable vape market in the US is sizeable, at about $9bn in revenue.
The problem, as BAT is at pains to point out, is that 70% of that market is illegal product. Marroco says BAT made the acquisition as an attempt “to understand a bit more the dynamics of these markets”.
So there are no plans to commercialise the product at this point. BAT will be piloting it in the next few months, trying to understand the dynamics of this niche in terms of cannibalisation and the source of business, and only then make a call on how it positions disposable products in its portfolio.
It’s an interesting move nonetheless. Its progress will hopefully go hand in hand with more stringent measures in the US to combat the influx of illegal vape products, which has markedly stubbed out growth rates in the legal market. Overall, trading remains tricky for BAT with a heap of moving parts that move very differently from market to market. Still, the group remains a cash flow beast as long as it can balance volume declines with pricing power in its core cigarette market … and keep growing its new category brands in competitive niches.
At the elevated share price, I’m undecided. I won’t lie.
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