Investment Panel

Photo: Malcom Griffiths

A New Case for Tobacco

Despite the rough ride for tobacco stocks in recent years, the investment case for tobacco and nicotine remains strong, according to the participants in the Global Tobacco and Nicotine Forum (GTNF) 2021 investors panel. Under the direction of Eric Bloomquist, four prominent tobacco analysts—Jonathan Fell of Ash Park Capital, Rupert Wilson of Strategic Business Consulting, Pieter Vorster of Idwala Research and Gaurav Jain of Barclays—debated the outlook for tobacco in a rapidly changing business environment. Even as the industry suffered from Covid-19-related fallout, its legendary pricing power remained intact and continued to deliver profit growth and cash flow. With supply chain disruptions affecting many sectors, tobacco has even become a safe hiding place again, one panelist ventured.

That said, some companies have clearly done better than others. Those with greater exposure to noncombustible products are attracting higher valuations than those with a lower portion of their revenues coming from that business, and the panelists debated whether that discrepancy would prompt investors to pressure the underperformers to “get their act together.” Not everybody was convinced. As one participant pointed out, shifting the world’s 1.1 billion smokers to noncombustibles is a very long-term project. “Realistically, there is time for the companies who don’t have the right strategy to eventually get there,” he said. A word of caution was also uttered against compromising the cash flow machines: The transition to less risky nicotine products requires lots of investment, and many of those funds are still generated by sales of traditional cigarettes.

Speculating on possible mergers and acquisitions, the panelists considered a reunification of Altria Group and Philip Morris International unlikely in the near future. As one participant pointed out, PMI has publicly committed to deriving more than 50 percent of its net revenues from smoke-free products by 2025. Because Altria currently receives a smaller share of its earnings from such offerings than does PMI, it would be harder for the combined entity to meet PMI’s target. What’s more, many PMI investors like the fact that they can currently choose whether or not they want exposure to the uncertain U.S. market—an option that would no longer be available after any merger.

One panelist suggested Swedish Match as an acquisition target for PMI. After the recently announced separation of its cigar business, Swedish Match would offer PMI attractive complementary smokeless businesses, such as snus and modern oral, the panelist said. Others contemplated the possibility of spinoffs by Imperial Tobacco, which has announced greater focus on its core markets. The problem here, noted one panelist, would be the buyer: With all large tobacco companies keen to reduce their dependence on combustibles, there is no obvious taker for such a business—at least not among the publicly listed firms. This, in turn, led to speculation about the designs of China’s State Tobacco Monopoly, which is not accountable to shareholders—but the panelists quickly agreed it was futile to figure out “what is happening in China.”

The discussion then turned to the impact of environmental, social and governance (ESG) initiatives on investors. Would tobacco companies’ efforts to transition smokers away from deadly combustibles prompt investors who might otherwise have shunned the sector to take another look? Panelists agreed that the Foundation for a Smoke-free World’s Tobacco Transformation Index, which evaluates tobacco manufacturers on efforts and actions relating to tobacco harm reduction, could prove to be a valuable tool for investors. Companies that are doing the most in this area are already enjoying the best valuations, one panelist pointed out. They also pointed to the entrance into the market of new nicotine companies that offer no combustibles, such as RELX and SMOORE, which have broadened the options. PMI’s recent acquisitions of pharmaceutical companies, such as Vectura, could also generate interest from a new class of investors, the analysts ventured.

At the same time, the panelists acknowledged the challenges facing tobacco companies in escaping the tobacco “taint.” Many financial websites offer investors a dropdown menu with the option to exclude “tobacco”—a broad label that includes both companies wedded to traditional cigarettes and firms at the forefront of transitioning smokers away from such products.

One panelist detected a marketing opportunity. Its premise would be simple: Rather than pretending tobacco companies don’t exist, such a fund could offer to invest in their depressed stocks and help them change. “That would be a useful approach for the world and an interesting proposition for investors,” he said.