Chit Chat Stocks - British American Tobacco (Ticker: BTI) Not So Deep Dive

Episode Date: November 7, 2023

British American Tobacco plc (BTI) is a global tobacco and nicotine products company, operating in various markets, although it faces challenges related to declining smoking rates and regulatory pressures in the tobacco industry. Listen closely as Brett and Ryan go through the history, financials, and future prospects of the company. Enjoy the show! ****************************** Chit Chat Money is presented by Interactive Brokers. Switch to the best brokerage in investing today: ⁠⁠ibkr.com/info⁠⁠ ***************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: ⁠⁠https://chitchatmoney.substack.com/⁠⁠ Want updates on future shows and projects? Follow us on Twitter: ⁠⁠https://twitter.com/chitchatmoney⁠⁠ Contact us: ⁠⁠[e-mail]⁠⁠ Timestamps Company Background | (2:15) Industry | (21:35) Management & Ownership | (27:17) Earnings | (33:40) Balance Sheet | (36:25) Valuation | (38:54) Our Analysis | (41:49) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Anything discussed on Chit Chat Money by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. All right, welcome in everyone. This is the Tuesday not so deep dive episode on chitchat money. My name is Brett Schaefer. I'm joined as always by my co host Ryan Henderson, and we're kicking off our sin stock theme this month. For anyone that doesn't know, which I think most people do, but I do like to explain it. Each Tuesday, we analyze a different

stock. It's usually one we haven't covered closely, but we just pick a theme for the month. We choose a collection of stocks. We research them, kind of try to get our first time opinions, first time looks at it. We've only been covering it for a few days. So obviously it's not going to be the same as if we've owned the stock for three to four to five years or something like that. We're doing sin stocks. We're kicking it off with British American Tobacco. We're going to hit MGM Resorts. We're going to hit Smith & Wesson. We're going to hit Altria Group at the end what other one am i forgetting ryan oh diageo diageo the alcohol giant now before we get started i want to say if you want any of the data the charts the graphics any of the stuff that we're

referencing throughout this newsletter subscribe for free or excuse me that we referenced in the podcast i kind of spoiled it there subscribe to our free newsletter the link will be in the show notes. You get that delivered to your inbox on Tuesday to go along with these episodes. We think it's a great pairing with each one. It's also a great way to follow the show. We give some of our thoughts and stocks, various things over there. I guess that's really my purview. But yeah, subscribe to the newsletter, Best Way to Grow the Show. You can listen to these anywhere you get your podcasts, Spotify, Apple, or YouTube. But let's get right into it. We don't like to ramble too much. So Ryan, we're hitting British American Tobacco. It is a giant multinational

company so as best as you can do what does british american tobacco what are their operations british american tobacco we're probably going to call them bti for short their ticker is bti i think it's their adr at least in america it's like b-a-t-s i think in london but we're going to call them bti today is the second largest tobacco company in the world really um except excluding the chinese market i think that whatever the chinese tobacco company is i think that might be larger actually than any of the others but uh we basically exclude that for for looking at this market so bti second largest tobacco company in the world there are a couple of ways you can break down bti and some of them do it by like in in their investor relations pages

press releases, annual reports, they break it down by market geography. I think it's better to probably go by product categories. So BTI operates three different segments. Really, I'd say two important ones, but combustibles is their biggest one, new categories, which is all-encompassing, and then traditional oral. So let's start with combustibles. This is predominantly their cigarettes business. There's some other tobacco products here as well. I think they have cigars, but most of it is cigarettes. It accounts for 82% of BTI's overall revenue. Unlike Altria and Philip Morris, though, which have split geographies, BTI sells their brands globally.

That means US, Europe, Middle East, Asia, pretty much everywhere. I think South America as well. Everywhere but China. And Russia. Now, well, maybe they're in the process of getting rid of that. But anyway, so they sell globally and they have a couple of recognizable brands that include Camel, Newport, Lucky Strike, American Spirit, trying to think of some other ones here. Rothmans is quite popular. And in total, about half of BTI's combustibles business comes from the US.

So lots of, even though it is a global business, they are kind of US heavy here. And BTI has an estimated 35% market share in the United States versus Altria, which I think is at like 52. So second largest player there. Don't you think it's funny? Not funny, but it's an exemplification of, or wait, no, that's not even a word, an example. I don't know what I'm talking about right now of how strong the Marlboro brand is because by itself, it has a larger US market share at like 40 something percent than British

American tobacco's entire business. Yeah. And I will say British American or BTI has been growing combustible share by like 20 basis points on average over the last three years. So it's slight market share expansion, but still, yeah, small, even relative to Marlboro. the brands in bti's combustible segment also they span the market in terms of price or like value so they compete in the premium space they also compete on the lower end so it's not just all focused on one but in general this business combustibles won't be much of a surprise to people here they're experiencing volume declines so from 2009 to 2022 british americans cigarette shipments fell 16% in total. However, those declines have been much sharper in the US and they've actually been accelerating in recent years, especially with the spike in fuel prices

here in the US. There's been a correlation apparently, this is common. I was looking back, I was having a hard time finding evidence of this, but when fuel prices spike, less trips to the convenience stores or gas stations, less purchases made of cigarettes. And also the rise of the new categories combined with that, which I guess you're about to get to. Yeah. I was going to say it might be a little different this time in terms of why there's this big shipment decline because they've gone through the cycle before, or at least Altria has,

where typically they're seceding anywhere from like 2% to 3% of their volume each year, but it's accelerated in the past. I think like 8% volume declines at its worst. Then it came back up, and now it's back to that level. The concern here, we'll talk about this. You said Altria, you mean BTI, right? No, I'm talking specifically about Altria, but I think it's indicative of U.S. cigarette business overall.

So I'm assuming, I didn't see the BTI shipments in like the 20, I think it was like the 2012, 2010 timeframe. They had this big decline and people are kind of referencing that now because the declines are accelerating. The difference is there's a lot more alternatives in today's world in terms of getting your nicotine consumption. But that leads us to our new category. So this is the second biggest business line or revenue line for BTI, and it consists of three different brands and really three different product categories. So three product categories are Vapor, Heated Tobacco, and Modern Oral, aka nicotine pouches. In total, these three brands account for just basically 12% of total revenue, but it's rising quickly. And they expect that, or I think their goal is that by 2025, they are generating $5 billion in revenue from these three categories, which would be a significant increase from here.

Let's start though with the vapor category. So their main brand here is Vuce or Vuce. It is the number one vaping brand globally, having now surpassed Juul. Although, Vuze, it's the number one vaping brand globally, but it started as this refillable vape. So, you had the stick, you'd buy new juice or whatever, put it into the Vuze, and then you'd smoke that vapor, or I think it's called synthetic nicotine, I think is the term. But that was the process. Then over the last, I'd say, five or so years, disposables have become really popular. And so sometimes you'll see market share quoted and it doesn't actually encapsulate.

Can you hear that siren? Yeah, but continue. Sorry for the audio. Anyway, so disposables have become really popular. So sometimes the market share stats don't account for that. So it can maybe show like higher share than Boost really has. But they actually recently launched VOOS Go in 24 different markets, which is a disposable product. So they're trying to grow there, kind of offset the competition from other disposables like the Elf Bar and there's tons of other different ones. But most of the revenue for VOOS comes from the US. So we're going to talk about some of the other new categories where they don't really have a US operation. VOOS generates a lot of it from the US. And so this is maybe a red flag for me down the road because the vaping space in the US is basically a crapshoot right now.

Um, and revenue growth of all the three new categories has been slowest at the vapor, uh, in the vapor category. So modern oral and heated tobacco, which I'll talk about in a second are growing a little quicker, at least on a percentage basis. So let's move to heated tobacco. For those that don't know, this is, it competes with Philip Morris's Icos. If you're a US consumer, you might not be that familiar with it, but basically it looks like a vape, but you put cigarettes in, or I think they call them heat sticks, and it heats it. It doesn't burn it. It reduces the amount of harmful chemicals. So it's supposed to be better for you. It's supposed to be a reduced risk product, but you buy the heat sticks separately too.

So you can buy the individual cartridge thing, and then you actually buy the heat sticks. Their big brand here is called Glow. This is the second biggest new category product that they have. And it's actually been growing really quickly, 24% year-over-year growth in 2022. They don't have, or they haven't launched this in the US. I don't think there's really any heated tobacco products in the US. uh so really all the revenue right now is coming from europe apac in the middle east i do think well i'll save this question for later but there is the potential that they move into the u.s market over time the last one i'll talk about here i've been going a little bit long um velo so velo is what they call their modern oral product basically it's just nicotine pouches think zen if you're in the u.s you probably know or you've heard of zen velo is very similar They are the market share leader for nicotine pouches in Europe, but it's much smaller here in the U.S.

They released a product that there's like a U.S. specific product, which I think is like lower nicotine levels. It's older and it's just a worse product. It's generally not as loved as you can see from the market share differences by U.S. consumers. Yeah, apparently I've spoken with some people about the Velo products and the European Velo is like, I don't know, they love them. but the US version is just really soft and muted. You don't really get the same hit, if you will. But revenue in Europe was up 31% last year, driven entirely by volume growth. There's a little bit of pricing there, but still, it's actually quite a small revenue driver for the overall business. So even though we talk about VLO, GLO, VOOSE, all these categories, VLO does

not really generate that much revenue, even though it's growing quickly. It seems the European market for nicotine pouches generally is just smaller than the US market. So even though they tout themselves as the number one market share, just remember that it's not that big of a product relative to BTI's overall business. Which is a good or bad thing, right? It could say, oh, there's more potential if this is going to take over the world and be one of the number one products for nicotine consumption, but also, okay, what's holding it back? Right now, probably regulation, but we'll get to that, which is a major headwind for this company. Last thing I'll touch on is just traditional oral. This is mostly just chewing tobacco and

moist snuff. The biggest brand is Grizzly. They also talk about having, I think the brand was called Camel Snus or Snooze. I think it might've been discontinued because I'm not seeing it listed on their website anymore, but it has been in previous investor presentations. So it doesn't really matter. Small part of the business, just think this is chewing tobacco and the business is declining. It's getting eaten away by, no pun intended there, it's getting eaten away by a lot of these other new categories or nicotine pouches, stuff like that. So slowly shrinking, but I do think it's quite profitable for them. They don't break it out specifically, but I imagine this is a pretty profitable brand that they're no longer investing much growth spend into. I've got two

questions here though, because I know that was a lot. BTI has a lot of different products. I think there's two important discussion questions for us to take away and we can talk about them now. Do we think heated tobacco would be popular in the US? And then follow up, if Velo gets clearance to have its European product here, do we think it can compete effectively with SYN? I'm sure we'll discuss this even later because there's other important facts to these two questions. With heated tobacco, it seems like there's never been a big marketing push never been a big investment from these companies i know altria had phil morris international's license for their icos product which is the number one product out there

i think it can but it seems like it's going to be much smaller than vaping or vapor products there i don't know is is the question i think with the velo one it's probably too late probably too late yeah i think i'd probably agree with that it's even a velo does have like a like a fair product maybe the products are similar to zen maybe even better zen's just a habit at this point for a lot of people they recognize the flavor they don't ever really switch i mean i think they have like 70 market share right now in the u.s And On, which is Altria's nicotine pouch business, has been discounting a lot and they're still just not really growing share.

So it seems like people have basically opted to Zinn as the default, but I guess that's kind of a TBD. Let's talk about the history really quick. Kind of interesting just because all these tobacco companies that are around today are just so old, like have so much history. So the company's roots date back to 1902, the UK's Imperial Tobacco Company and the American Tobacco Company, which great corporate names. I love those. We've moved from the Imperial Tobacco Company to VOOS or GLOW without a W. Although British American Tobacco is still, they're one of the only holdouts here for their actual corporate name. But yes, I agree.

it's uh the old names were just what we do country anyway so they formed a joint venture to cross sell each other's cigarettes in their respective markets buck duke was i love that name buck duke became the company's first chairman he was highly focused on mechanizing production and trying to become the low-cost provider worked well they began expanding on really expanded their operations globally into a number of different countries, smaller markets, and they did it through a lot of acquisitions actually. However, in 1912, during I believe it was Roosevelt's trust busting kind of campaign initiative, we saw this with Standard Oil, the American Tobacco Company was forced to divest its stake in the joint venture. So

this basically became a UK business, even though they had operations internationally, it was a UK company, and they were listed on the London Stock Exchange that same year. But to enter new markets, like I said, they would typically just acquire the local player. In fact, by 1927, they had 120 different subsidiaries. So after basically 20 years, 25 years of operations, they had 120 subsidiaries. While this might all sound irrelevant because it was 100 years ago, they did establish the local distribution networks in all these areas that It served as the groundwork for parts of the current modern day distribution system. So they would get like local suppliers.

They do the manufacturing locally, the distribution locally. It wasn't like there wasn't one grand distribution center that spread out to the whole world. They had these localized distribution systems, which is still, from what I understand, the way they run today. uh other other things about the history throughout the great depression they generated about five million pounds each year which is kind of testament to the business testament to how recession resilient tobacco is in general so i mean five million dollars in profits throughout the great depression is kind of incredible they did however collapse to just three million pounds of profit during world war ii apparently it really hurt operations but coming out of it

bti i think was still the name or british american let's call it um they they began growing pretty quickly following the war and became the third largest company across british french and germany german companies by profit so this was for pretty much the last century one of the biggest european businesses um out of basically all european corporations the 1960 and on from basically 1960 to 2000 they were acquiring a lot of stuff that was unrelated to the business they acquired paper companies cosmetics food companies they got into the financial services space and then they slowly started divesting all these things so it's just kind of this series of acquisitions and divestitures but by 1994 bti or british

American acquired the American Tobacco Company. So the reuniting of the two businesses, and that's when they added kind of the Lucky Strike brand to the portfolio. There were some other ones in there as well, but Lucky Strike was the most popular. And then the only other big events that I think are worth mentioning is over the last decade, so starting in 2012, they really began investing in these new categories. And in 2016, they finalized a deal to acquire the remaining stake of Reynolds American, which added a ton of debt to the balance sheet, but that's where they're at today. And the acquisition was, it seemed okay. It didn't seem like crazy expensive. I think it was like eight or nine times EBITDA, which based on where they're valued today, it's similar.

So it's not like they bought it at some crazy expensive multiple relative to where they currently trade. Anyway, that's the history. I think that covers just about everything up And until today, do you want to go through the industry and competition? Chitchat Money is brought to you by Interactive Brokers, but we like to call them by their ticker symbol IBKR. Designed for active traders and sophisticated investors, Interactive Brokers offers trading assets in 150 markets with 27 different currencies, charges USD margin loan rates from 5.83% to 6.83% rated the lowest among margin fees, the ability to trade stocks, bonds, options,

futures, commodities, and more with high interest rates paid on instantly available cash balances and the ability to lend your eligible stock shares to earn passive income all on one single unified platform. Restrictions may apply. For more information, visit IBKR.com. Member SIPC. Open an account with IBKR today. Sure. So as a note in the newsletter, I will link to a nice little succinct data report on the cigarette industry that has some good graphics also included, which I think is a very important graphic here in there as well. So in order to understand the industry, I think we should look at cigarettes and then everything else. So firstly, with cigarettes, it's a

bifurcated market on a global basis. So you have two different dynamics. One is kind of the North America and Western Europe areas where volumes have continued steady declines for reasons we're well aware of, taxes, health stuff, regulations, new products, et cetera, et cetera, et cetera. However, in lower and middle income countries, cigarette consumption is on the rise. Generally, the market share of volumes is increasing in places like Africa, Middle East, and Asia, and then conversely falling everywhere else and british american tobacco has quite a bit exposure to a lot of these areas for example they talk about big growth in pakistan and stuff like that kenya or maybe not kenya egypt you know countries like that which could be an opportunity or

also present some risk just given the the currencies the local governments stuff like that. So here's a quote. Between 2006 and 2020, cigarette sales in the Asia Pacific region increased 7.5% to 235 billion sticks for the Middle East and Africa region. Sales increased 15.3% to 65.5 billion sticks for the same period. Add all this together and you have declining volumes globally, but rising retail sales due to pricing power. Here's another quote. between 2006 and 2020, the global cigarette volume sales decreased by 3.5%, while real retail values increased by 24.3%. Now, if we go to the everything else, which is really the, quote unquote, new categories or risk-reduced products, you may refer to them as either,

there's a lot more uncertainty, but also a lot more potential for growth. There are varying projections, numbers, estimates, and everything else you can get for these categories. But I kind of think of it like this. The potential is really the entire global population who is currently consuming nicotine, mainly in the form of cigarettes. And then if you exclude the $300 billion or so coming from China, the industry is around $300 billion to $400 billion. And that's, honestly, that might sound a bit optimistic. But if you think eventually a lot of people stop smoking cigarettes or and switch to these new age products there is a ton of revenue potential for these things over the next 10 20 years so clearly there's a like the nicotine products

that we talk about here vapor uh modern oral heat not burn yeah there's they're not very big part of this business today but they're and there's a lot of uncertainty like we probably mentioned time and time again with with a lot of these markets a lot of these products but the opportunity is massive and a lot of companies are trying to go after it it's why all these large tobacco companies have made so many acquisitions in this space anything you want to add there ryan before i go to management and ownership no they're kind of like uh in between philip morris and ultra like in terms of geographies they serve where it's like they've got some of the u.s which the u.s declines at a much faster rate than a lot of the other markets but they've also got

a lot of philip morris's markets well i don't know it's kind of like a feels like a good in between and then they also like altria has zero good things going on in the new category space Philip Morris seems to be the leader and British American seems to be kind of right in between. So I don't know. Do you just split the valuation and just give them the middle there? Is that what they deserve? Well, management at Altria, even though historically kind of bad, might be quite a bit better at actually generating value for shareholders compared to BTI. but I also, I think one thing investors should consider with the international exposure for

British and American tobacco is one, weighing the foreign exchange headwinds if you are a US investor or a United Kingdom investor or wherever, because there's a lot of risk when selling stuff in Brazil, Pakistan, or wherever. But the population gains in a lot of these areas, honestly like the it's going to counteract a lot of any any volume declines and create a big addressable market even if they have to still sell things for cheaper they'll still there's like the population in these areas could grow by a billion over the next 10 20 years so i think that's something to think about theoretically like it would take a while for this to happen But as the volumes decline faster in the US, the chances of further declines for British

American overall should diminish because they're getting more and more of their volumes from those growing markets, even though they're significantly smaller than the US in terms of actual retail or actual revenue. Right, right. Exactly. There's a lot of things to balance. it's hard to think about sometimes with this company now listen to management ownership i have a note i didn't really get any ownership figures here as with a lot of european companies

it you struggle to find the exact figures that are updated i also don't think it's very important here management general i don't think is a giant positive for this company and i don't it's more of like okay stop being bad it's kind of an inverting like okay it's not like So it's not a giant, you know, like, why would I buy this? Because the management's super good. It's like, okay, are they actually not as bad as people think? So if we get to management, they're run by, and apologies if you're listening to this and I mispronounce your name, but I'm going to call him Taddeo Morocco.

He was appointed CEO in May of this year. So just got the job and has climbed the ladder at the business since joining in 1992 in the Brazilian subsidiary. A real insider hire here, he's had 10, 12 jobs at the company and just continued to climb up. He was previously the CFO from 2019 until his promotion. Why did he get the job in May? Well, it could be quite the coincidence, but the old CEO, quote unquote, retired effective

immediately when news came out about the company violating sanctions and selling into the North Korean market. They are paying a $600 million fine for this, and it looks to me like they fired the old CEO because of this news coming out. However, my question here is, wasn't Morocco almost assuredly aware of these payments? He was the CFO.

So, any thoughts? Yeah, I would guess that he should have been aware. the wow where's all that revenue coming from who knows just lump it into the other category or maybe like we're seeing great growth in apac yeah fantastic volume gross okay well they are they have a lot of stuff they have a lot of executives they got a lot of board members they got a lot of esg stuff probably about 80 pages in that annual report which is just a bunch of nonsense they spend a lot of time colorizing animate animating illustrating those annual reports i would like them to focus maybe not so much on that maybe more on their actual governance

put that e or put that g in esg but let's move to the important part for the management and that is the executive bonuses and what they're based on this is the thing we care about the most so they're based on a lot of metrics unsurprisingly they got one of those consultant type confusing ones, but their bonuses are based on group volume share. So that's like, you know, number of cigarettes, number of pouches or cans, number of vapor units that they're selling is based on new categories, revenue, new categories, contribution, profit, group adjusted operating profit. And then I think there was group adjusted operating cashflow, but basically just adjusted operating profit as well. And then long-term stock options or performance options

are based on three-year hurdles for comparative total shareholder return, earnings per share, which is not comparative. The only one that's comparative is total shareholder return, group revenue, and cashflow conversion. From an executive comp perspective, the only glaring red flag to me is the relative total shareholder return, because honestly, who cares about relative returns what are your thoughts here in general on the management team culture should given their track record and i have a chart here about how their total shareholder return has been flat over the last 10 years and even though they've generated an absolute boatload of profits at a low valuation should we have any confidence in this management team and culture

well there i do think it's worth noting that their valuation basically got cut in half so they're multiple so on the total shareholder return stuff what's it look like if they stayed at the same multiple i think that's fair to ask that part slightly out of their control also i don't necessarily know some some of their capital allocation hasn't been that bad like okay they've got a whole bunch of money now tied up in the indian tobacco company it seems like that money might not go anywhere but that might not have been a bad investment like in terms of that actual business performing well so it's just kind of hard to recognize that value now but i think bummer that they sucked over the last decade but it might be a great

set up now because of some of this they maybe recognize some of their mistakes in the past they've like you said generated a bunch of cash flow and dividend dividended a lot of it out they're still continue to raise that dividend and maybe the reynolds maybe they overpaid for it but i don't know i think they're in decent shape here and and i a lot of it comes from that multiple compression so i don't necessarily fault them for that yeah that the next board Meaning they're going to be like, guys, our stock hasn't gone nowhere for a decade. What do we need to do to improve things? And then someone's going to pipe up.

Well, I think maybe we should stop selling into North Korea. Is that possible? Oh, yeah, that could be a good idea. So yeah. We should add another 10 pages to our ESG report. Yeah, wait, no, it's like that meme where the guy gets thrown out the window for the ideas. It's like, stop selling to North Korea.

And then the ones that they choose, add more ESG initiatives. Yeah. but either way as ryan mentioned the bar is low they haven't been absolutely terrible probably better than some other players in growing the new categories but let's get to earnings ryan what do you think here for reference to everyone we're trying to keep everything consistent in british pounds i know in the industry ones i gave dollars but i think people can understand that uh but we're keeping everything in british pounds and just kind of take that for what you will it's it's kind of hard with the currency conversions. All right. Let's go through the earnings real

quick. So starting big picture, BTI did 28 billion pounds in revenue over the last 12 months. Gross margins are really high on that. So around 80%, 35% free cashflow margin. I'll also mention that they report an operating margin, which is solid to track, but given the interest expense, it's not the most important figure for shareholders. So the one good thing about tobacco companies generally is they don't massage earnings. They do care about cashflow and they care about what they can pay out in a dividend. So their EPS figure or their adjusted EPS figure is probably the most important thing to track. Moving to the recent first half report though, total revenue was up 4.4%. They're helped by foreign exchange, unlike a lot of the companies

we've looked at, which have been quite hurt by it. So revenue growth in constant currency was just 2.6%. But like I said, a little better after foreign exchange. That was driven by combustibles revenue up 2%. And that was combustibles revenue grew 2% on 6% volume decline. So saw good pricing growth there. New category revenue was up 29%. Vapor was the weakest out of those. So heated tobacco and velo were both growing quicker. And then traditional oral revenue was down 9%. Sharp volume declines. The business is in a tough spot, but hopefully producing cash to reinvest into the new categories. Adjusted EPS grew slightly quicker than revenue. So up 3.6% in constant currency, basically kind of looking at this business,

just provide some context here, 8.8 billion in trailing 12 month net income. So kind of think, or sorry, 8.8 billion pounds in trailing 12 month net income. So as we kind of talk about the valuation here in a second, just remember kind of that's what they're earning on the last 12-month basis. I'll say they aim to pay out 65% of their adjusted earnings per share in dividends. I think the path to earnings per share growth is pretty simple here. You get slight declines in combustibles volume, you offset it with price increases, and you get 10%, 15% plus new category revenue growth. If they can do that, I think they're on a path to grow EPS, maybe even towards the double digit range, kind of high single digits, which at this valuation,

we'll talk about in a second, would be probably more than enough to make shareholders happy. Let's talk about the balance sheet though. 4 billion in pounds on the balance sheet in cash. They generated 14 billion pounds in EBITDA over the last 12 months. I usually don't care about EBITDA, but because they're incredibly levered or not, they're highly levered. So it's relevant here. And then the last thing I'll say on the asset side, BTI also owns a 30% stake in the India Tobacco Company, otherwise known as ITC. ITC has a market cap of almost $50 billion. It might've changed since I last looked at that, but that would value BTI stake at around 15 billion, roughly. I mean, that's substantial relative to BTI's market cap, but they're not

planning to sell it. I don't even think they're allowed to sell it. Not really sure, but they basically said, this is a strategic investment. We're not planning to sell it. However, they do collect dividends from it. And ITC, I believe, does spinoffs, which allow BTI to monetize it. So I think there's a hotels division to this India tobacco company that they either were planning to spinoff or did spinoff, which then BTI can sell some shares. So even though the money's locked up, it might be valuable. And you might think, well, we're never going to see that value, I do think that that business is growing and they're collecting dividends in the meantime. On the liability side though, and I'll ask you about the ITC thing in a second, but there's a

lot of debt. Much of that was acquired through the 2017 acquisition of Reynolds, but 42 billion pounds in total borrowing. So 38 billion pounds in net debt. The average maturity on it is about nine and a half years. The cost of the debt on average is 4.3%. Most of the debt is fixed. They do, however, like to have some floating rates. So about 14% of their debt is floating rate, mostly denominated in US dollars. They're trying to delever right now, just given where rates are at. So they aim to keep their leverage ratio, which is just net debt to adjusted EBITDA between two and three times, which that's right where they're at. So I think that's a good strategy. And 4% cost of debt isn't too crazy. Yeah. All right. Well, I guess my opinion on

ITC, I can get to that and how to value it in my valuation section. So I should say that I'm going to use enterprise value to operating income here. And as Ryan mentioned, the interest rate or the interest payments are important, but I think it's... The reason I use operating income is because you want to, I think, as an investor show what the market is value on that, and then maybe do some sort of projection on what the interest payments will be if their average cost on their interest rises from, say, maybe 400.3% to 4.8%, 5% or something over the next five years, because that could impact your bottom line profitability. But the math I did on the EBITDA operating income was just taking 2022 operating income.

Don't think that's the end of the world for a very unvolatile business. I put value on dividend payments from ITC. I just took the payment that ITC gives BTI and then just put a 15 times multiple on that. I think that's probably the best way to do it just because it's uncertain whether they're going to be able to sell that stake. But if they pay them back in dividends, well, that's the money you can actually eat as a BTI shareholder. And then I added back the net debt and kept everything in British pounds. Currency movements, they're going to remain unpredictable.

Yeah, you can try to model that out, but it's probably going to be a fool's errand. Question I have, does an EV to operating income of eight feel right here? i guess i i think that's attractive as as a potential investor i think it's attractive i wouldn't necessarily yeah i want to expect multiple expansion but if you i think it depends on the uh what happens obviously but if they can if they can like have volume declines that were more in line with history and less the recent history so like not six percent volume declines i think that's a little too low right and we should say that they are dealing with a what you probably would call a one-time impact from

a menthol ban in california which they had the largest exposure to for the cigarette category and we will talk about the regulatory stuff that maybe is getting discounted in discounted here into the stock price which they've had plenty of headwinds in not even just the california menthol ban voos has had some velo has had some it goes on and on and on and it seems like nothing is falling right for them and then also i think the management is discounted here into this so let's move on to what more of our opinion stuff anecdotal evidence ryan what are your thoughts here we're not users of any of the products but what do you think of these these brands that i guess it's kind of like it's kind of like what do you think because we have friends that you know

obviously they use these things so yeah well okay so i only have perspective on the u.s market it seems like to me and a lot of the thesis here is that basically new categories will continue to grow and maybe over time replace the revenue loss from cigarettes i think in the u.s aside from zen the rest of the new category space is a crapshoot i don't know who the vaping leader is going to be i don't think there will be one regulations market share changes all market share changes all the time regulation seems either non-existent or just like random because it's weird to me that some of these elf bars are okay but they're not apparently there i mean apparently the elf bars are not okay but no one's cracking

down so it's quite interesting where bti has lobbied a ton and time and time again saying look these things are pretty bad for kids and stuff like that like we're following by the rules here these guys aren't you need to ban them they technically are not supposed to sell them but there actually hasn't been a crackdown so it's kind of a weird spot where it's like all right regulators do your job but should we expect them as shareholders to do our job or is it more likely that the status quo remains i think it's a hard one to figure out yeah so uh vaping seems like a toss-up heated tobacco no idea if it's going to work here i kind of feel like if it were going to work it would have worked already maybe there's been some regulatory hurdles there but

it doesn't seem like there's a lot of interest in the u.s for that and then uh oral oral nicotine modern oral zen feels like they've won in the us and so i don't know i don't have a lot of optimism for bti's new categories or new category products at least here in the united states yeah and i will say anecdotally the the one optimistic thing would probably be probably be the european modern oral market and they dominate that one with the better velo product and that is small right now but i think it is highly attractive growing quickly i will say philip morris international did purchases in and has been trying to revamp their marketing plays out there they've lost it seems like in the nordics but i think western europe eastern europe

and a lot of other markets still have probably it's uncertain who's going to win there so I think generally tons of uncertainty into the new categories, but tons of potential. It's probably good that British American tobacco has a lot of irons in the fire there. They just don't have anything that's proven to be kind of a modern Marlboro or Camel or what have you, or, you know, even outside of tobacco. In the CPG space, you're looking for something that turns into, you know, the Coca-Cola, the Pepsi, the Lay's potato chip, the Tostitos, the Gatorade. Nothing is really separated from the pack in these categories, which at least the opportunity there, but right now tons of uncertainty question.

I have your anecdotally. Do you think looking back was the Reynolds acquisition a mistake? I think it probably was because of the volume declines that I probably weren't priced into that thing. Yeah. And the debt now they have no flexibility. Yeah. I think you probably could say it was a mistake.

not not horrible because it's been profitable for them but the volume declines accelerated right after like i don't think there is it's kind of just unfortunate for them but i'd say yeah that was probably a mistake do we want to move to uh future growth opportunities sure so i have one which is the one we talked about the introduction of the quote-unquote good velo to the United States. The company is still waiting for regulatory approval here for its new nicotine patch formula in the country, which, you know, it's done quite well in Europe.

It's beat Zin in Europe, which I think has some investors optimistic here. You know, the U.S. nicotine patch market is large, growing quickly, and has the best unit economics in the sector by far, according to these management teams. Do we think, we already said, we think it's probably too little too late,

but could they really dethrone Zin? Is there a path for that? Because it seems like you'd have to have so much marketing that maybe isn't even possible given the regulation. Yeah, the other thing I'd be afraid of is you probably got a discount.

You probably got to be cheaper to get people to try it first. I said no earlier that it feels unlikely to dethrone Zin but Because they've been so successful in Europe, and some of the people I've talked to that are avid nicotine pouch users, that they've imported this stuff from Europe or they've gotten the good velo, and they say they love it. So maybe there is a way.

I would be a little concerned. It's going to be expensive, and they're probably going to have to sell at lower margins to really get user adoption going here in the US. Yeah, because Zena has such good lock-in at the convenience stores, the gas stations, the points program. I have a friend that got an iPad, I think, from the points program, power user. But what's your future growth opportunity? it just that's just an example of how strong the zen lock-in is in the united states but ryan what's your future growth opportunity what do you think or bti maybe the voos go so this is their new disposable product that had launched in the uh 24 new markets it's i guess if you can't fight

them join them uh or if you can't beat them join them which with these disposables so many of them just seem like they probably aren't healthy and they probably shouldn't be on the markets and they're illegal and you know someone ought to do something but if your views and they're eating your lunch you know launch a disposable so i well i don't know what the reaction is going to be i don't know if they'll get like a positive response because it seems like people in america love the colorful bars that like all have weird names but i think that's probably one area that can maybe help re-re kind of invigorate the voose volume growth but i don't know they need regulatory clarity in i think the big overarching growth opportunity especially when it comes to the menthol stuff for

cigarettes as well is with generally globally with new categories and us as well with just the cigarettes with the menthol stuff i think a future growth opportunity is just regulatory clarity which the fda or whoever this the body is there could be separate ones they don't seem to be doing very well and they seem to be taking their sweet time when making these decisions yeah i mean the future growth opportunity is all in the new categories right like you have to see strength there for this to i mean if volume declines aren't as bad in cigarettes that's great for shareholders but it's it's not something i'd call future growth opportunity the i like the heated tobacco and maybe they can compete with icos in europe but

just doesn't seem like it's a us kind of product maybe that changes over time but it's yeah future future growth opportunity is all encompassing new categories i think you got probably got to grow revenue 15 to 20 percent for at least five years to hit that five billion figure and we should say when ryan mentioned earlier about the overall revenue growth not you know being kind of small right like stable and cigarettes with the price increases but then you add on this 10 to 15 growth from the smaller category get some minor revenue growth but the consolidated margins should expand as new categories go from unprofitable to profitable and as you raise prices on the combustibles category with declining volumes those margins go up as well so i think that's pretty

clear is as long as new categories revenue continues to grow margins on a consolidated basis have an easy path to climb higher. All right. Highlights, lowlights, what do you like and dislike about this business, Ryan? Highlights, I like that they have a global revenue mix, especially given the environment with combustibles in the US right now. Maybe this is something we should talk about. Do you think... So volume declines have gotten pretty bad in the past at times, but I think it got to minus 8% for Altria in the 2010 timeframe. maybe it was 2009 but they came back to kind of the minus two minus three percent now they're back to 11 do you think this is something where it's just gonna start climbing back up to lower like

we're just going through like a second cycle here or do you think there's enough alternatives today that this is different well with chewing tobacco i think it's clear we've hit gone past the i don't point of no return and i think this time is different given how fast the modern oral category is going growing with cigarettes i'm i don't have confidence either way yet because on the one hand you could argue about the vaping and the heated not burn products but those have been growing so much and if that was a direct impact on cigarettes i think it would have shown up much more right but i think it's probably eating a little bit so it's hard it's hard to tell how much because given how popular vaping is like you would have if it was like all

of vaping was stealing from cigarettes i think you would have expected that to show up in the data much more sharply it definitely has some impact i'm not sure exactly how much so and how much vaping is going to grow from here i'm not caught like is vaping gonna continue to gain um volume growth in the i'm not i'm not sure about that i'm pretty confident that cigarette volumes will continue to decline i think the 11 percent that ultra saw and the accelerated rate that bti saw might have been just kind of a perfect storm of bad events for them because you had the rising fuel prices kind of a tightening of consumer spending generally and they always toss out the excuse of yeah they're trying they always toss out the excuse

with them all which i'm always hesitant to uh to like believe them on is they always say oh no it was a channel like it was just inventory moves on the channel stuff you know like oh it's just you know what i mean i always feel like that's an excuse but the truck was a day late that moved into q4 exactly exactly basically that's what i'm trying to say there but on a on a larger basis they try to give that excuse sometimes and that hat that can occur but uh i think they could i don't think they'll decline at this rate forever there's also maybe less like social proof for cigarette smokers than there used to be like if i see a cigarette smoker on the street i'm kind of like oh oh you like you're still doing that okay that's that's kind of uncommon you know

you just don't see it as much anymore and maybe seattle you also live in seattle yeah yeah nah get out in the country you're probably right but a lot of people live in the cities and i imagine that used to make up a good amount of the volume for ultra yeah i don't think that i don't think that's relevant you don't think the social changed if you went people that people still think young people still think it's very cool if you went to go smoke cigs you think your friends would be like oh dude that's sick or do you think they'd be like yo do you need help no i mean when people i think it's less like acceptable today yeah but that was the same in 2010 as it was in 1980 comparatively to 1980 but it's like so i'm like the volume

i don't think that should affect volume declines but they are accelerating or all trio since like last 10 years it was down 42 relative which previously was declining like 30 each decade right what i would probably say is the new categories yeah that's probably fair anyway okay let's go back to highlights uh forwards earnings multiple is roughly half of what has been over the last decade so i i wouldn't just look at the last decade's results and be like oh no total return there's no chance you're getting one here like i think if anything you're much more likely to get a good return from here i would say don't discount that though don't ignore it like do you think a good man like if we get the best managers out there i would say don't

ignore it but yes right makes a good point uh ceo being fired probably positive but being replaced by the cfo is a little weird low lights for me even though we i just said ignore it but uh The total return has been bad, and they've wasted – reluctance to say wasted money, but it would have been nicer if they just simply returned it to shareholders over the last decade. You probably would have gotten better returns. Maybe my biggest low light here is that I don't really have that much belief in their new categories. I don't believe that those can really hit that $5 billion mark. that it feels like they kind of just threw five billion out there to like that's a nice round number for shareholders it's like who knows maybe we can hit it maybe we can't hey growth yeah to

be fair we have anecdotally or just kind of our thoughts on these products we have less confidence but the growth overall it's been uneven but it's been pretty good despite some headwinds it hasn't been as crazy as good as philtmore's international but it has been good and i guess philtmore's international had to acquire swedish match for what like 17 billion so yeah i would say probably the biggest excuse they would have here is the foreign exchange headwinds for the us market so like the returns have been flat in the us but i think they would argue hey look the currency conversions are out of our control my highlights first one globally diversified and category diversified revenue mix i think they you know they're in most geographies most nicotine

categories essentially whatever way the wind ends up blowing in the sector they should do fine unless they have a total blunder from an operational perspective because we did talk about the volume declines accelerating in the in the us and some other markets and potentially that could hurt them but if they can execute with velo views and glow they should be the ones picking up these these volume clients. Now we talked about Philip Morris being a little bit better than BTI at this point, but it's much better than Altria or Imperial or anyone else. Also, I think new categories growth, as Ryan mentioned, we don't like these brands as much, but the growth has been solid. And I think it has an underappreciated profit inflection coming as they have been

unprofitable. And once they inflect profitability, as they say they're going to, I guess you got to believe them it should help on a consolidated margin basis and then they already have the global distribution which i think helps launching vo in i believe they talked about like pakistan and stuff like that so i think that gives them an advantage over upstarts although philip morris international has the international distribution as well lowlights for me i just have management listed three times in a row and then regulators i would also add i forgot to write this down foreign exchange that's a lot of headwinds a lot of stuff here well management isn't within their control but regulators and foreign exchange somewhat out of their control regulators they

can lobby but those are some major low lights for me okay ryan what's your bull case how does this stock work going forward well there there have been good write-ups over the years lots on value investors club and i want to plug our friend uh devin lasar he had a really good write-up on his sub stack which he calls invariant and follows all these companies very well or yeah and if you just if you believe so he gives out some reasonable assumptions let's just i'll kind of run some numbers out verbally you tell me if you think it's reasonable okay okay two percent volume declines in cigarettes for the next five years annually yep okay it seems fair maybe it could maybe be a little bit worse

five percent price increases annually combustibles yeah ten percent new categories revenue growth yeah flat or better earnings margins operating margin just whatever yeah I don't see any reason

sure it should interest expense yeah but it's interest expense is like isn't moving that much

because only 14% is floating rate debt but I guess they're going to refinance yeah okay maybe a little more interest expense

but i still think flat you could get flat yeah sure two percent share reductions annually maybe uh maybe maybe okay i don't know how much room there's gonna be depends how much they want to dividend i would say if they kept the dividend flat on an on an absolute payment basis yes it depends on they should have the capacity yeah exit multiple in four years maybe five years ev to operating income of eight times doesn't change sure you could probably get 15 returns with all those right uh i'm i forgot all the numbers yet but you gotta add up all those numbers in your head yeah let's just call it three percent revenue eight to ten eight to ten

percent earnings per share growth they increase the dividend payment every year in line with that and the multiple doesn't change you're probably at least getting double digit returns total return yeah yeah adding the dividends you get yeah well it's just what does management do with the cash so far. Give it back to us. Maybe that's why they hired the CFO.

You know, he knows. Yeah. Yeah, I mean, it can work. That's kind of my thing too.

It's like, if operating earnings can stay flat or even grow just with all the dynamics from what I mentioned there, you probably may get abandoned

as long as management just doesn't go, look, we're going to, they're just saying, we're going to run things that we're running them and we're not going to try

to overthink things. And then, you don't have the us dollar is just a major headwind again which how much worries do you have about that it's so hard to predict that's why i get worried about it could be you're right yeah yeah i mean it's happened for a while it could also go the other way i have absolutely no idea because i'm not a currency expert yeah and if you are i think even the current one of the currency the true macro traders drug and miller said he had no idea what currencies were going to do so i should stick with that but i think that does i should i think it does mean

you should discount this for if you live in the united states you should discount this on everything else is equal same exact company europe versus us i'm discounting them because of the uncertainty i think that's fair yeah bear case for me honestly i think the floor is pretty high here when you have a nine percent dividend yield i think it takes real it's gonna take really quick volume declines in cigarettes for this to get you a negative return over five years and that just doesn't feel realistic so i think the floor is pretty high yeah and as ryan mentioned nine percent dividend yield tax-free accounts if possible everyone and don't reinvest that's the big question do you reinvest what do you mean

Yeah, I wouldn't either. I don't know. Maybe if it was Philip Morris. If I had more belief in the new categories, if there was maybe further proof, like two years down the road, I could change that. Yeah, I don't think the idea is crazy of buying the big three tobacco companies,

not reinvesting dividends, and then using those proceeds to buy other things in a non-taxable account. Mine's the same. Management concerns. Management continues to make mistakes. I have a lot of confidence this stock is undervalued. but that might not matter because management and foreign exchange okay lastly more or less

interested ryan more interested i think of our it's just like not like the big three tobacco companies i i've got more belief in philip morris than any of them to grow earnings at more than 10 a year and i really believe in the new categories of philip morris i'm not sure on these two or on Altria and British American. And so I'm comfortable maybe making that a slightly bigger percentage of the portfolio because I'm a little more confident in their ability to grow. British American and Altria, I would be open to, like you said, non-taxable account, just collecting that dividend. You're buying it when volume declines are at record levels so i think the likelihood that that happens again is is diminished and you're probably buying

them at half the multiple you're buying them at a decade ago i'm not saying that justifies it but if it gets down if the chances that you get your multiple cut in half again are extremely low certainly lower than it was a decade ago and if that does happen well the returns would look probably even better okay so at these prices philip morris international or british american and tobacco i will say i'm interested as well similar thoughts i would take philip morris here well i take them both but i'd maybe but at this at this price what one would you buy first by first i'd probably buy philip morris first yeah well i think i lean they don't both i know but i'm saying which way if you're ranking it yeah the earnings multiples valuation comes

into play like i leaned at these prices phil morris international but if it got a little bit more expensive i think it's i think it's close i think it's fairly close yeah i think that's fair i do think the next decade's returns among the big three tobacco companies like the total shareholder return i i don't think it looks like it has the last decade i don't think ultra wins that oh interesting well we're gonna hit ultra at the end of the month and i think we can kind of decide the big three there we did cover philip morris on another podcast in more detail if you like this episode you're gonna like that one went a little longer but i think it was a fun discussion next week we're covering mgm resorts again if you want all the graphics

charts all that good stuff we'll have the link to that in the show notes we'll still have the links to all the other write-ups and data that we got. Thank you everyone for tuning in. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan and I may have positions in the companies discussed on this podcast.

Thank you everyone again. We'll see you next time. Thank you.