If you're getting a 15%, 16% annual return, it's a defensive business – Philip Short, Flagship Asset Management.
SIMON BROWN: I’m chatting with Philip Short, senior equity analyst at Flagship Asset Management. Philip, I appreciate the time today. [We are talking] tobacco companies. Locally it’s British American Tobacco on our exchange. Lots to like about tobacco companies; lots to worry about, however.
SIMON BROWN: And part of that – there’s lots to it – is they’ve got the New Age products. But part of it is just good old-fashioned taxes and the like. But further to that, there is also regulation around ‘flavoured menthol’. I know California restricted flavoured cigarettes and they managed to get a fairly significant shift in terms of those who were on menthol.
So you do have people who will either drive to neighbouring states where there aren’t bans and load up, or there were people who just moved to traditionally flavoured cigarettes. You will also find that not what the tobacco companies sell but what other sort of curio shops sell is almost like a little piece of tinfoil. You can cut that up, put it in your bag of normal cigarettes, normal flavoured cigarettes overnight. You will see [them] become like menthol. So there are ways around it.
PHILIP SHORT: It’s about 45% of revenues, and menthol makes up about half of that. So menthol is quite big for them. I think that the important thing to appreciate for British American Tobacco is that when they increased their exposure from 40% to Reynolds to 100%, there’s a great pathway to pricing power that’s still available in America.
SIMON BROWN: And we have seen, certainly there, what they call their premium brands within British American Tobacco, that pricing power. But then the story has sort of shifted away from combustibles, and now it’s what they call ‘next generation’ products, most notably vaping. They’ve spent a lot of R&D on that. But it is gaining traction.
PHILIP SHORT: Yes. Hard currency. So if you’re getting a 15%, 16% annual return on that investment, it’s a defensive business. You’ll see if you look at the earnings variability on the bottom line on an organic currency basis, as much as the rating has gone up and down on the tobacco companies – especially British American Tobacco – the earnings have been quite consistent and they’ve paid out a progressive dividend year after year for as long as I can remember.
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