Sunday, August 1, 2021

Checking on Re-Nicotinization Thesis

With big tobacco (and small tobacco) results for the first half of 2021 now in, we can check on the progress of the Re-Nicotinization thesis that we wrote about back in February. (Be sure to read that post before reading this one.)

What we have posited is that even if the cigarette business is in volume decline (but hopefully profit stasis), the nicotine delivery business is a growth business because society is craving nicotine for its dopamine releasing and nootropic properties.

Here are the highlights from the Altria (MO), British American (BTI), Philip Morris (PM), and Swedish Match (SWMAF) earnings reports.

Smokeable product volumes were down 5.1% but net revenue was up 1% and operating income for the segment was up 7%. Oral tobacco revenue was up 4.6% and income up 0.3%. The strongest part of the oral tobacco segment was the Red Seal (dip) and on! (nicotine pouch) products that had unit volumes up 39%

I'm guessing that the strongest growing product was the on!, because we are seeing unbelievable growth in all of the tobacco companies' lowest risk products. (At BTI, this is vapor, heating products, and modern oral; at PM this is heated tobacco; at Swedish this is the Zyn pouches.) What is interesting is that Altria acquired this from Swiss tobacco company Burger Sohne for $372 million. 

Altria total operating income for the first half was $5.9 billion, up 14.5% - more than the smokeable and oral tobacco segments were up, because the wine business went from loss making to slightly profitable. (Also remember they just reached a deal to sell this.) Oral tobacco products are now 10.5% of revenue and 14.4% of operating income.

Philip Morris
[Also see earlier results discussion.] Cigarette volumes were down 2% but cigarette revenue was up 1%. Heated tobacco units were up 30% and reduced-risk revenue was up 39%. Overall revenue was up 10% and operating income was up 19%. The heated tobacco (reduced-risk) unit growth was strongest in the EU, up 50% for 1H 2021 vs 1H 2020. 

People love PM's heated tobacco (IQOS) product. Which makes sense, since PM is the leader of the big three in the reduced-risk nicotine transition, with 29% of revenue now derived from heated tobacco.

British American
Cigarette volumes were up 2% but revenues were down 3%. Note that for the big tobacco companies (PM and BTI) with multinational operations, it can be difficult to untangle the effects of currency movements. At constant exchange rates, the revenue for cigarettes was actually up 6%.

Non-combustibles revenue was up 20%, with "traditional" oral tobacco volume down 3% but vapor (Vuse) up 70%, heating products (Glo) up 99%, and "modern oral" (Velo pouches) up 124%.  At constant exchange rates, non-combustible revenue was up 29%.

Operating income was down 4% (although in constant currency it was up 5.4%).

Swedish Match
A tiny company compared to the others, Swedish Match demonstrates the same pattern as the other three: in the U.S. only, snus volume up 5%, chew bags down 8%, and pouches up 63%. Smokefree revenue up 10% and total operating income up 31%.

Combined Valuation
Together these four made $18 billion of operating income in the first half of the year. Their combined market capitalization is $345 billion, or just short of 10 times 1H 2021 annualized operating income. Note also that the combined earnings were up from $16 billion in the first half of 2020.

Just look at the gigantic revenue and volume increases in the reduced-risk products. What is particularly striking is that the further you get from burning tobacco, and the closer you get to pure nicotine (the pouches), the faster revenue is growing.

These reduced risk products also demonstrate a thesis I have that millenials and yuppies don't know what anything should cost. That is, you can get away with gouging them a lot more (higher margins) than you can salt-of-the-earth cigarette smoking proles. I think it is actually partly ignorance, and partly status anxiety making them not question prices. Also, yuppies operate in segments of the economy where people don't negotiate as much. 

Anyway, whatever the reason, Philip Morris' safer heated tobacco product is growing more quickly and has higher profit margin and selling price than its cigarette product. And the same seems to be broadly true of all the reduced risk products.

There's a reason that everybody at Apollo mission control, everybody at every coffee shop, everybody at every bar and at every dinner, and everybody in every classroom was smoking cigarettes back before they were acknowledged to be harmful (and more importantly, déclassé): nicotine is an enjoyable nootropic.


Allan Folz said...

It could (also) be that lighter taxes on newer products leave more margin on the table for the companies, whereas with cigarettes governments are soaking up lion's share of the profit.

Stagflationary Mark said...

First, a possible correction.

Note also that the combined earnings were up from $16 million in the first half of 2020.


Now, a thought.

The secular trend for tobacco is unquestionably down. If you are long the tobacco companies you’re on the wrong side of the trade.

I joke. I saw the following quote on the Yahoo Finance message board for TLT about 3 months ago. Filed it away for future potential amusement.

“The secular trend for bond yields is unquestionably up. If you are long the TLT you’re on the wrong side of the trade.”

In hindsight, perhaps he should have questioned his obvious trade. TLT has had a great 3 months.

“Markets are constantly in a state of uncertainty and flux, and money is made by discounting the obvious and betting on the unexpected.” - George Soros

I think that’s exactly what you are hoping to achieve with tobacco companies. To a much lesser extent, that’s also what I am hoping to achieve with utilities. The headwinds for both are obvious to all. But the potential rewards? Perhaps not so obvious to all.

As for Tesla and bitcoin, the rewards are clearly obvious to all, but perhaps not the headwinds. Yet.

CP said...


Compare the big tobacco dividend payment history to that of utility companies:



Stagflationary Mark said...

I’m in. Three tobacco stocks are now a third of my IRA. Feel pretty good about it. It took me time to warm up to the idea, but I’m embracing it now.

My best investment was based on an addiction, so why not embrace it?

I’ve seen it first hand. In the late 1990s, I saw a man walk up to the counter of a game store with packs of Magic: The Gathering cards in his hands. He paid cash for them. I watched him open the packs and not find what he was looking for. He then walked back to the shelves and grabbed more packs. He walked back to the counter, pulled out his credit card, turned to me and said, “Magic plastic.” Had a big grin on his face. What he didn’t know, and I didn’t tell him, was that I was in the store solely to see how the game that I invested in was doing. Needless to say, this anecdotal evidence far exceeded my already high expectations.

That’s when I knew that it would probably retire me. Didn’t take long after that. Felt like I’d just won the lottery. Addicting card game combined with addicting credit. Powerful combination. Magic plastic. It’s a two word phrase that I will never forget.

CP said...

Mark, did you go with the Big Three?

Stagflationary Mark said...

Yeah. I double weighted BAT (ticker BTI) though.

That brings my IRA to roughly 2/3 VPU, 1/6 BTI, 1/12 MO, and 1/12 PM.

CP said...

Oh yes, I see the blog post:

CP said...

Perhaps it's time to give oil and gas royalties a ponder?

Stagflationary Mark said...


The main tax complication of DMLP is that taxable holders must report distributions as partnership income including the separate items furnished in what is known as a K-1 form.

I’d want to put it in my traditional IRA. From what I’ve read over the past hour or so, that complicates it even further.

To buy it, I think you have to have the view that, while electric vehicle sales may continue to slowly grow, the worldwide ICE vehicle fleet is going to keep growing too.

I mostly believe, although I do own a battery operated lawn mower, hedge trimmer, weed eater, jigsaw, drills, reciprocating saw, and chainsaw now. So, there’s that. I like the convenience of batteries, lack of fumes, and the quiet.

Remember that U.S. explorers and producers lost an incredible amount of money over the past decade. They burned their debt and equity investors…

Seeing oil trade below $0 was more than a bit shocking. Even as a bystander, it negatively affected my confidence. If that can happen, what else can happen?

CP said...

Interesting to look at the dividend history of DMLP

Although crude for immediate delivery traded below $0, the futures didn't.

I'm not worried about what happens to oil when the economy shuts down.

You do have to satisfy yourself about the Demand Question and the Supply Question though.

CP said...

The Partnership previously declared its second quarter distribution in the amount of $0.480528 per common unit payable on August 12, 2021 to common unit holders of record as of August 2, 2021.

CP said...

I may write a blog post on the costs vs benefits of using nicotine.

Potentially beneficial aspects of nicotine:
- cognitive enhancer / nootropic
- energy booster
- appetite suppressant
- anti-depressant / mood enhancer
- sociability enhancer
- "protective action against nigrostriatal damage" (Parkinson’s disease)
- competes with covid for ACE2 receptors

Potentially harmful aspects of nicotine:
- vasoconstriction
- tachycardia / other cardiovascular effects
- upregulation of ACE2 receptor expression (covid risk)

Other aspects to consider
- tolerance / adaptation (net benefit, same question as caffeine)

Let me know if you have other potential costs, benefits, or aspects to consider. (Or any good evidence regarding the aspects that I have mentioned here.)