Big Tobacco 2020 Results & Links

Reading some interesting things lately regarding tobacco:

• Charioteer Investing had a post on Altria's Q4 earnings, with a good observation about price discrimination to extract the most consumer surplus from cigarette smokers: "Cigarette List price Increase of $0.14/pack. Technically this was announced on January 20th and not during earnings, but it deserves special attention. This is the 4th list price increase in the last 12 months, cumulatively totaling $0.46/pack. For reference, 2019 price increases totaled $0.25 and 2018 was at $0.19, so this is a massive increase. MO also announced a Manufacturer Supported Off-Invoice (MSOI) rebate in select states, which means that MO is proactively making moves to protect its brands (especially market share leader Marlboro) from downtrading. Management has mentioned multiple times that it is using consumer data to generate more targeted marketing and discounting schemes, and I think the fact that they were able to announce an annual price increase that is 2-3x above trend while simultaneously targeting discounts to select consumers shows an increasing level of sophistication in targeting that should get even more refined over time."
• Ash Park Capital had the excellent observation in a white paper at the end of 2020 that big tobacco equities (PM, MO, BTI) are very cheap relative to their bonds: "Virtually all Tobacco bonds now offer a yield a lot lower than the coupon; 70% of the outstanding debt yields less than 2%, and 99% yields under 4%. A fairly frequent cry from commentators is that investors are worried about the level of gearing in Tobacco stocks, but that’s not what credit markets are saying. The equity valuations of our Tobacco stocks seem exceptionally pessimistic now. [I]n the case of BAT, the current valuation is implying that cash flows are close to their peak and will start to decline at quite a rapid rate in the next 10 years or so. The credit market will lend these companies 30-year money at well under 4%, whereas the equity market demands dividend yields of 6-8% and attributes essentially zero value to cash flows after year 30."
• A natural experiment in Australia shows the inelasticity of demand for cigarettes: "The sustainability of current levels of profitability and returns on capital depend on the positive impact of price/mix being at least in line with the annual volume decline. As some point in the future, we anticipate a tipping point at which the consumer is no longer willing to continue to accept price increases above the broader rate of inflation, leading to an increase in price elasticity. The example of Australia gives some insight into how such a kink in the demand curve might occur globally. Since 2011, a series of Draconian anti-cigarette meaures in Australia have led to the introduction of plain packs and tax increases that caused the doubling of the retail price of cigarettes in just six years, which in turn has lead to the smoking rate falling from 16% to 13% over the same period, and to significant trading down between price segments. A pack of 20 cigarettes (equivalentl a standard pack contains 25 sticks in Australia) now costs roughly $14.50, well above the $10.40 average retail price in the U.K, $5.50 in the U.S., and around $5 on average globally... Assuming the Australia experience is applicable to price elasticity in other markets, it appears likely that there remains a great deal of headroom for price increases globally. At 4% real pricing this crude calculation suggests that it will be 2046 before global pricing reaches levels at which price elasticity increased in Australia."
  
• Noticed signs last summer that the cigarette business is stabilizing: "We saw the chart below showing that cigarette volumes were actually flat y/o/y in recent weeks. That is encouraging because we did not like how cigarette companies were maintaining revenues by continually raising prices faster than the rate of inflation. It is a better sign if the volumes plateau with some core group of smokers who aren't 'quitters.'"
• An astute post on big tobacco's plan to corner the market on vaping of nicotine and cannabis: "This would effectively cede the ENTIRE electronic cigarette space to the big players. Only the big players can afford to comply with a complex approvals/disclosure process--it would put all the small importers of various Chinese-made products out of business in the U.S. because they will not be able to afford this kind of testing/QC. The more burdensome/labyrinthine the regulatory process becomes, the better it is for PM/MO with their armies of lawyers and quality engineers. This will be the same play in the cannabis space if and when the big players are ready: bury the small competition in regulatory bureaucracy. This is what worked in the cigarette space for decades. This is why there are now only a handful of giant companies selling a commodity product with in developed markets. No one else can afford to."
• Here is an example of big tobacco lobbying for legislation to squash smaller vaping competitors: "As part of the 'Consolidated Appropriations Act, 2021,' in the most recent COVID-19 relief bill signed into law on December 27, 2020, Congress amended the Prevent All Cigarette Trafficking ('PACT') Act to apply to e-cigarettes and all vaping products."
  
• From my original post on tobacco in October 2019: "What is fascinating to me is that these tobacco stocks seem cheap at the same time that nicotine is making a huge comeback. Nicotine is a drug that, like ethanol and caffeine, has stood the test of time. Does society crave it now after having cut back so sharply? Maybe people will resume consuming nicotine at very high rates, but in a different form." 

My notes on Altria's Q4 2020 earnings results: 

• Current market cap: $79B, debt net of cash: $25B, enterprise value: $104B
• 2020 EBITDA: $11.3B (EV 9.2), 2020 Net Income: $4.5 billion, 2020 Net Income + JUUL impairment: $6.1 billion (adjusted net income)
• Adjusted P/E (ex JUUL Impairment): 13x
• Value of BUD stake: $10.6 billion
• Market cap (ex BUD stake) vs adjusted net income: (79-10.6) / 6.1 = 11.2x
• Cash from operations: $8.4 billion, dividend: $6.3 billion
• Smokeable products 2020 vs 2019: revenue net of excise tax up 6.5%, operating income up 10.8% to $10 billion
• They said they will target 80% payout.
• Cigarette volumes in Q4 2020 were up 3.1% vs Q4 2019. Oral tobacco volumes were only up 0.5% by comparison.
• Altria's latest debt maturity is February 2059. It yields 4%. Assuming for the sake of argument a constant 8% dividend yield on the equity, you would make your money back in about a dozen years. But you'd only get back half your money in interest from owning the debt over that time period.
• We should do quite well if the underlying business (cigs/smokeless) is at least stable. Could be an incredible win if society turns back to nicotine in safer ways (JUUL, heat not burn) and big tobacco controls it. 

 My notes on PM's Q4 2020 earnings results:

• Current market cap: $133 billion, net debt: $26 billion, enterprise value: $159 billion.
• 2020 EBITDA: $11.7 billion (EV 11x), 2020 net income: $8 billion
• P/E: 17x
• Cash from operations: $9.8 billion, dividend: $7.4 billion
• PM's biggest market is the EU, where they earn $5 billion of operating income. Next biggest are East Asia & Australia ($2.4 billion) and South/Southeast Asia ($1.7B).  
• Revenue from combustible products fell from $24 billion to $22 billion in 2020, while reduced risk products grew from $5.6 billion to $6.8 billion.
• Even though cigarette shipments fell 11% and combustible revenue fell 10%, income grew.
  

We are still waiting for BTI's year end results. Here are historical dividend yields for MO, PM, BTI. The yield for BTI is 7.2% based on last year's payments.