Big Tobacco struggles to convince investors it can quit smoking

Big Tobacco’s bets on smoking alternatives are starting to pay off. Britain’s British American Tobacco expects its non-combustible business to turn a profit by 2025, while at Marlboro maker Philip Morris International nearly a third of revenue comes from such products.

But, as PMI chief financial officer Emmanuel Babeau clarified in an interview after the results this week, the reduced-risk business model relies first on creating smokers and then converting them.

Asked about a significant increase in cigarette sales above pre-pandemic levels in the Middle East and North Africa last year, despite PMI’s stated goal of “smoking out the world”, Babeau told the Financial Times: “Our ambition is to convert smokers to our [reduced-risk] product. If we lose the connection with the smoker, we cannot easily convert it to the product. »

Tobacco’s continued health damage leaves some investors skeptical of corporate transformation efforts. One of Imperial Tobacco’s top 10 shareholders said, “The problem is that tobacco is becoming almost impossible to invest in. Many investors consider excluding it from their portfolio.

After the fallout from mass litigation in the United States in the 1990s, cigarette companies became a popular investment due to their reliable returns for shareholders. Big Tobacco has had “one of the most consistent earnings growth in the world, with 100% of cash generation returning to shareholders,” said JPMorgan analyst Jared Dinges.

Some are happy to continue supporting the sector. For Duncan Artus, chief investment officer at Cape Town-based asset manager Allan Gray, the surge in illicit cigarette sales in South Africa during a pandemic tobacco ban proved one thing: “It’s hard to stop To smoke“.

Allan Gray more than tripled his stake in London-listed British American Tobacco last year and is the fifth largest shareholder in the maker of Lucky Strike with a 3% stake.

Cayman Islands-based billionaire Kenneth Dart, an activist distressed debt investor, also increased his stake in tobacco, making it the second-largest holding in BAT and Imperial Brands last year.

But these are rare figures in a community of investors who turn their backs on tobacco.

According to a 2019 study by Seattle-based asset manager Russell Investments, nearly 70% of large-cap U.S. equity managers had dropped tobacco from their portfolios by June 2018, with little impact on performance. performance.

This trend has pushed companies to develop reduced-risk products, although some are more advanced than others.

BAT comes in second, but trails PMI by some margin on Friday, indicating that 12% of revenue came from non-combustible products last year. This figure is 3.5% for Imperial, while Altria, maker of Marlboro in the United States, and Japan Tobacco International do not disclose these sales.

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The varied progress is reflected in stock prices. As PMI shares recovered to January 2017 levels, when prices began to decline on concerns over falling smoking rates and US tax threats, shares of BAT and Imperial fell. 36 and 50%, respectively.

Strong performance in the lower-risk sector can offset fears about a company’s long-term future, Artus said, adding: “Fuels is almost 100% of earnings, but people are going into commodities. new generation. It is only the evolution of the share price.

But, as one of Imperial’s top 10 shareholders pointed out, investors who sell tobacco offer an “opportunity for [companies] to buy back their shares” and support the price.

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BAT said on Friday it would buy back £2bn worth of shares next year and did not rule out further returns. PMI launched a three-year buyback program of up to $7 billion last year. Imperial is also expected to launch a buyback program this year.

While these offer short-term returns for shareholders, tobacco companies ultimately want to be viewed as sustainable investment prospects. Although there has been a regulatory crackdown on vaping in the US, the UK NHS has found that vaping is 95% safer than smoking cigarettes.

According to BAT, a broader perspective on ESG is emerging, where “investors are willing to engage in actions that transform, whereas in the past they may have taken a more exclusive”.

Babeau said investors can see the company’s “fundamental transformation” and that its strategy of providing alternatives to smoking “promises to deliver substantial public health benefits over time.”

PMI’s takeover of inhaler maker Vectura last year and BAT’s investment in cannabis and a biotech launch this year show how companies are looking to diversify.

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But many investors remain skeptical. Another shareholder from BAT’s top 10 said: “I don’t think tobacco stocks will ever have a place in ESG or sustainable products – that would be too big of a change, given that they are the biggest exclusion. spread of wallets.”

Sébastien Thevoux-Chabuel is wary of the scale of the change required. The head of responsible investment at French asset manager Comgest, which excluded tobacco stocks in 2016, said: “The transformation . . . needed is so huge and so risky that we wouldn’t be able to get conviction on which stocks to invest in the tobacco sector, even if companies move to lower risk portfolios.

Such attitudes cast doubt on long-term investment in tobacco. “If in 10 years [reduced-risk revenue] is very important, there could be pressure from investors to split the company,” Artus said.

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It’s a strategy for which Stockholm-based Swedish Match plans to separate its combustible and non-combustible businesses this year. Although analysts do not expect such moves to trigger a rush to buy stocks: “Tobacco – even without combustion – [is] still too difficult to explain to fund investors,” Panmure analyst Rae Maile wrote in a recent note.

Yet South Africa’s experience suggests that the world is not ready to give up smoking. “You want fuels replaced,” said Jonathan Fell, a partner at consumer goods investment firm Ash Park Capital. “But the traditional tobacco trade is not going away for a while. It’s a very sticky habit.

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