Naspers v BAT

In terms of growth prospects, Naspers is smok­ing BAT

Financial Mail - Investors Monthly - - Front Page - Stafford Thomas

Which JSE giant is smok­ing hot?

Bri­tish Amer­i­can To­bacco (BAT) and Naspers are poles apart when it comes to op­er­at­ing en­vi­ron­ments, but in the in­vest­ment world it is the risk/re­ward mer­its of com­pa­nies that re­ally count. Right now, the rel­a­tive mer­its of the two com­pa­nies put Naspers as a “buy” and BAT as a “sell”.

Naspers has the wind in its sails, thanks in large mea­sure to its 34% stake in Chi­nese on­line giant Ten­cent, while BAT faces a se­ri­ous risk to its prof­itabil­ity.

Over the years BAT, which owns brands such as Dun­hill, Kent, Lucky Strike, Pall Mall and Roth­mans, has over­come ob­sta­cles rang­ing from clas­s­ac­tion law suits to health-risk warn­ings on cig­a­rette boxes. But it may not be able to avoid heavy fi­nan­cial dam­age from the lat­est chal­lenge.

Bear­ing down on its £14.75bn an­nual rev­enue is an on­slaught from the US Food & Drug Ad­min­is­tra­tion (FDA).

FDA com­mis­sioner Scott Got­tlieb dropped a bomb­shell on the US to­bacco in­dus­try in a speech on July 28.

“To­bacco use re­mains the lead­ing cause of pre­ventable dis­ease and death in the US,” said Got­tlieb. “But much has changed in the land­scape of to­bacco prod­uct reg­u­la­tion and [the] FDA’s abil­ity to address this public health cri­sis.”

The FDA’s statute was amended in 2016 to give it far greater au­thor­ity to reg­u­late to­bacco and other nico­tine prod­ucts.

Back­ing his as­sault on the to­bacco in­dus­try with damn­ing sta­tis­tics, Got­tlieb con­tin­ued: “The [US] death toll from cig­a­rette smok­ing is 480,000 ev­ery year while di­rect health­care and lost-pro­duc­tiv­ity costs to­tal nearly US$300bn/year.”

It is not so much nico­tine, the key to the ad­dic­tive­ness of cig­a­rettes, that is un­der at­tack. Got­tlieb’s main con­cern is the 7,000 other “in­cred­i­bly toxic” chem­i­cals in cig­a­rette smoke .

But the main thrust of his strat­egy is to ren­der cig­a­rettes non­ad­dic­tive by dras­ti­cally re­duc­ing or even elim­i­nat­ing their nico­tine con­tent.

Re­mov­ing the ad­dic­tive fac­tor would deal a se­vere blow to com­pa­nies ply­ing their wares in the $95bn an­nual-rev­enue market.

It also raises the ques­tion of whether other coun­tries will fol­low suit, should the FDA get its way.

What­ever the case, Got­tlieb’s speech spooked the market. On the day he de­liv­ered it, share prices of ma­jor in­dus­try play­ers plunged, with BAT and Al­tria, the big­gest play­ers in the US market, record­ing losses of 11% and 8.8%.

Re­duc­ing or elim­i­nat­ing nico­tine in cig­a­rettes will no doubt drive smok­ers to al­ter­na­tive nico­tine delivery sys­tems, in par­tic­u­lar elec­tronic or so-called e-cig­a­rettes. In prin­ci­ple it is a shift Got­tlieb said would be wel­comed.

The UK health depart­ment is also push­ing for a switch to eci­garettes as part of its drive to cut the num­ber of smok­ers from 15.5% of the pop­u­la­tion to 12% by 2022.

BAT has been pre­par­ing for the e-cig­a­rette on­slaught. Over the past five years it has pumped $1bn into a pro­gramme de­vel­op­ing new-gen­er­a­tion prod­ucts (NGPs).

But the NGP market is not one in which the firm faces just a hand­ful of ma­jor com­peti­tors. In the Chi­nese city of Shen­zhen alone there are more than 600 NGP pro­duc­ers.

New dy­nam­ics in the to­bacco in­dus­try come at a time of flag­ging global cig­a­rette sales. Ac­cord­ing to BAT, sales vol­ume fell 3% in 2016. It did well in 2016 to grow vol­ume 0.2% and rev­enue 12.6%, with half of the lat­ter thanks to a weak pound. Di­luted ba­sic EPS lifted 8.3% com­pared with a 5.3%/year New dy­nam­ics in the to­bacco in­dus­try come at a time of flag­ging global cig­a­rette sales av­er­age over the pre­vi­ous three years.

Pound weak­ness pro­vided an­other EPS boost in the first half of BAT’s cur­rent year. An­other kicker is set to come from the just-closed $49bn ac­qui­si­tion of the 57.8% of Reynolds Amer­i­can that BAT does not al­ready own.

Re­flect­ing the two pos­i­tives, the con­sen­sus fore­cast of 22 an­a­lysts calls for BAT to up EPS 13.8% in 2017 and 11.6% in 2018. These are solid num­bers, well above BAT’s nor­mal growth pace, but they have to be weighed against the risk posed by the pos­si­ble reg­u­la­tory change in the US.

Solid as BAT’s growth prospects over the next two years may be, they pale in com­par­i­son with those of Naspers — which also comes with se­ri­ous reg­u­la­tory risk.

Driven by Ten­cent’s surg­ing growth, the com­pany has in its past two years to March al­most dou­bled its EPS, with more of the same to come.

Ten­cent, build­ing on the base of the 938m users of its WeChat and Weixin so­cial net­work plat­forms, con­tin­ues to boom, with rel­a­tively re­cent ad­di­tions to its line-up such as on­line pay­ments and advertising kick­ing in. In its lat­est quar­ter to March Ten­cent trounced an­a­lysts’ con­sen­sus fore­cast to up rev­enue 55% to $7.18bn and net profit 57% to $2.109bn.

The con­sen­sus fore­cast by 15 an­a­lysts points to Ten­cent pow­er­ing Naspers’s EPS to a 47% rise in its cur­rent fi­nan­cial year and a 37% rise in the next.

Naspers is cur­rently trad­ing on a 32.3 p:e and BAT on a 22 p:e. How­ever, they are evenly matched on a two-year view, with an­a­lysts’ con­sen­sus fore­casts putting Naspers on a for­ward 15.8 p:e and BAT on a for­ward 15.6 p:e.

It only adds weight to the in­vest­ment case for back­ing Naspers over BAT.

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