PICK OF THE MONTH

“Cigarettes are being stigmatised as an unhealthy habit with costly implications for smokers and health systems

Delve into defensive stocks is probably conventional wisdom at this point. The problem is that the better-quality defensive stocks — some of which ply their trade in the “sin sectors” — can often carry a premium price.

British American Tobacco (BAT) might, these days, offer a more compellingly priced defensive position. The share — on the JSE — is up 22% so far this year. But it’s still 23% down over 12 months, and, on a trailing earnings multiple of 10 times and a yield of around 3.5%, appears to offer smouldering value.

Of course, there are several issues a buyer needs to contemplate before lighting up a BAT position.

Cigarettes are increasingly being stigmatised as an unhealthy habit with costly implications for smokers and health systems. Cigarette volumes have shown a steady decline, and there has been pushback against new-generation products (NGPs) like tobacco heating products (THP).

BAT’s interim results to end-June reported that total cigarette and THP volumes declined 3.5%, which it suggested was in line with the estimated industry decline.

BAT CEO Jack Bowles expected overall industry volume to be down around 3.5% for the full year.

But tobacco is habit-forming, which does give tobacco companies pricing power.

Bowles reported that BAT’s cigarette price mix was strong at 7%, driven by a good pricing environment.

There is also considerable traction in BAT’s THP thrust. Bowles said THP consumables revenue was up 15%, though device sales were scaled back in anticipation of the launches of the new glo Pro and glo Nano in the second half. Overall THP revenue rose 4%, but Bowles expected this to accelerate in the second half, driven by the new product launches.

BAT’s NGPs are gaining encouraging footholds. The interim report discloses that in the UK vapour represents 25% of the total nicotine market, and that BAT has a value share of 39%. Its Vype brand achieved a record value share of 11.6% in June on the back of the Vype ePen 3. In France Vype reached a value share of 17.3% — also led by ePen 3. BAT is now the No 1 player in the retail vaping market in France. In Germany, Vype reached 12% share of total vapour consumers, and in Canada Vype reached 21% value share.

Also worth noting is BAT’s success in the “oral” niche (Snus, snuffs and nicotine pouches), where it had market share gains in Scandinavia and Switzerland. BAT is the market leader in the modern oral category in Sweden and Norway with 57% and 73% volume share respectively. In Switzerland and Denmark BAT is also leading the development of the category with its modern oral offerings, achieving 42% and 67% volume share of this niche category respectively. The modern oral category has significant consumer appeal as there are no device requirements and no limitations on where and when consumers can enjoy the products.

Bowles reckoned the category has potential. “We are performing extremely well, with revenues up almost 300% in the first half.”

BAT remains the fastestgrowing nicotine product company in the key market of Japan. Its overall share of the total nicotine market has grown steadily, and in July reached a weekly record of 18.3% on the back of growth in THP and traditional cigarettes.

It is reassuring that BAT is still delivering on its promise to build up margin and generate strong cash flows to curb debt levels. FD Tadeu Marroco said BAT expected a strong secondhalf cash performance with a full-year operating cash conversion in excess of 90%.

He said BAT was on track to meet its target of £1.5bn of free cash flow after dividends, and reiterated that BAT remained committed to growing the dividend — citing a generous payout ratio of 65%.

Marroco is also standing by his “stretching financial guidance” given in March. In short, BAT — in constant currency — expects revenue growth in the middle-upper half of its indicative 3%-5% range. Adjusted profit from operations growth will be in the upper end of BAT’s 5%-7% range, and the group should continue to deliver on high single-figure earnings growth.

These are compelling numbers — especially for a group which is seeing demand for its traditional product snuffed out. Even sceptical investors will be wondering whether, in these times, a medium-term investment in BAT is reassuringly compelling? (Clears throat …) ●