Naspers v BAT
In terms of growth prospects, Naspers is smoking BAT
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.