It’s prudent to follow Jim Simons (Trades, Portfolio) and Lee Ainslie (Trades, Portfolio) into British American Tobacco (BTI, Financial) under $50 per share, especially since they are both down over 20%. British American Tobacco has vastly transformed over the past few years, gaining direct access to the American tobacco market by acquiring Reynolds American, a deal that closed last summer and should save the combined company about $400 million.
I’m not big on vice stocks, but I also do not believe smoking is inherently more dangerous than drinking a Coca-Cola. When I was a kid, I was addicted to Coca-Cola, drinking enough to get kidney stones at 12. Thankfully, my grandmother was a nurse and knew exactly why I was having this crazy pain that virtually paralyzed me. I never did touch cigarettes, but that was more a rebellious move against my parents who were both smokers.
I’ve known smokers that lived into their 70s and those that died at 53. Of course, those who lived longer typically didn’t compound their vice with other overuse in alcohol, sugar, red meat and any of the other countless products that humans can ingest that will harm their health.
The fact that we regulate so heavily bothers me more from a psychological level because it restricts freedom even if people individually find it hard to make good decisions. While I’m happy that there isn’t a smoking section in the restaurants I frequent or as many smokers walking around the city, according to a 2014 study, drinking a 20-ounch soda every day ages your cells as much as habitual smoking. While pharmaceutical companies, alcohol companies, and soda companies are able to push their products across marketing channels, tobacco has been blacklisted.
However, British American continues to grow. The advent of e-cigarettes (and vape stores), has created the most significant change in the industry since the 1960s, but e-cigarettes contain zero tobacco, only the nicotine in liquid form, which has its own negative health effects.
Nonetheless, the industry seems to be on the edge of a generational shift to a different set of consumable products. It seems likely that conventional tobacco will remain the driving force of the industry profit pool in the short term (10 years or so), but Big Tobacco manufacturers are placing money on the new categories most likely to win share of future smokers. And British Tobacco has a massive moat around it with brands that include Newport (the No. 1 menthol brand), Camel, Pall Mall (the leading value brand), American Spirit and Vuse (the No. 1 vapor brand)
From a purely business standpoint, adding Reynolds boosted British American to the world’s leading international tobacco firm and gave it a foothold on the next generation of products. While cigarette volumes continue to fall -- 3.5% estimated last year -- this new focus on vapor and tobacco heating products will be a major driver of growth in the years to come.
Current financials
- Annual revenue: 20.3 billion (GBP)
- Gross margin: 75.2%
- Dividends: $2.18 per share
- Book value: 35.18
Everyone knows that smoking cigarettes is bad for you, but as with most vices, this knowledge will not prevent a statistically significant portion of the global population from doing it. Just like the last decade, I fully expect the company to double its sales in the next decade, building an even greater profit-generating machine that serves people who really want their products. You know they want them because void of marketing, they keep selling more product. On one hand, the company saves a lot of money; on the other, British American can’t grow as fast.
You buy this one for the dividend because its competitive advantage will keep that dividend coming for many years to come, and as profits rise, the payout yield will get larger and larger.
Disclosure: I am not long/short any stock mentioned in this article.
