Not on fire, but still smoking

Sentiment for cigarette giant British American Tobacco (BAT) is getting unceremoniously stubbed out. From a local perspective one might argue that the strong(er) rand environment is muting market enthusiasm for the group — but BAT is down about 20% on the London Stock Exchange over the past three months and down only about 17% on the JSE over the same period.

I have a restless relationship with BAT. I detest smoking, but acknowledge — once I have scrunched up my scruples — that the BAT business is capable of sustaining smouldering returns for many years to come. What’s more, the quarterly dividend policy feeds my yield habit.

What I find encouraging in BAT’S recent financial report is that early indications suggest the acquisition of Reynolds America helped reinforce margins.

BAT CEO Nicandro Durante reported that, after two years of decline, the enlarged group returned to operating margin growth. The underlying margin improved by 110 basis points.

The group’s pricing power looks reassuring too.

Dirk van Vlaanderen, associate portfolio manager at Kagiso Asset Management, believes BAT’S price mix across brands of 5.5% is in line with historical averages and at the upper end of the company’s target of 4%-6%.

He believes this is not a bad result, given pricing headwinds and exciseinduced down-trading in some key BAT markets, such as Russia.

Van Vlaanderen contends that the tobacco pricing equation remains structurally robust and is likely to be further enhanced by the introduction of next-generation products (NGPS).

BAT disclosed that the combined NGP business (vapours, tobacco heated products and so on) delivered £500m of group revenue on an annualised basis in 2017, meeting the target the group set at an Investor Day in October.

Durante said BAT aims to grow this to more than £1bn this year and to £5bn by 2022. He is confident that the group will exceed these targets.

The 15% dividend increase certainly underlines this strident view on NGP growth.

Cash package

Transpaco is one of my favourite companies. It’s a relatively simple business that is tightly managed and has a knack for making clever acquisitions that don’t strain the balance sheet or the management team tasked with reshaping these assets into profit centres. The company also has a generous dividend policy, traditionally underpinned by reliable operating cash flows.

With this in mind, it might have been a tad disconcerting for shareholders to see operational cash flow for the interim period to end-december turning negative by about R2.8m. After dividends, interest and tax were paid, there was a net cash outflow of nearly R43m, eroding Transpaco’s cash on hand from R99m at the end of June to R36.5m.

CEO Phillip Abelheim contacted me last week to clarify the change in Transpaco’s cash utilised/generated for the six-month trading period.

Abelheim explained that as the year ended on a Sunday, a substantial amount of cash from debtors — which usually reflects in the company’s bank account at the month end — arrived on January 2 2018. Had the year ended on any other day, Abelheim said, the cash generated would have been R42m and the company’s cash balance a chunky R79m.

The BAT business is capable of sustaining smouldering returns for many years to come