Since we last wrote about BAT in March, relatively little has happened at the company. Despite this, the share has outperformed the All Share Index (ALSI) by 12% since February. The share price dropped by 13% in rand terms to a low of R619 per share in April, and subsequently increased by 25% to R771 per share at the time of writing, while also paying R17 a share in dividends. We increased the share’s weight in our client portfolios at around R635 per share.
The company’s reported results for the half-year to June 2018 showed like-for-like revenue growth of 2% year-on-year – at constant currencies and assuming the group had held 100% of US subsidiary Reynolds in the comparable period.
Volumes declined by 2%, compared to 3-4% for the industry, with BAT gaining a little market share, much like previous years. The price mix improved, more than counteracting the volume decline, much like previous years. Margins expanded slightly, much like previous years. Guidance remained essentially unchanged, much like previous years. The conversion of accounting earnings to cash was excellent, much like previous years…
So why the share price volatility?
- Since the April lows, the rand has depreciated by around 8% and BAT has played one of its key roles in our clients’ portfolios admirably: providing investors with a hedge against weakness in the local currency.
- In April, global peer Philip Morris – essentially the business of Marlboro outside the US – reported a slowdown in the exceptional growth rate of its heat-not-burn product, iQos, in Japan. This prompted the market to rethink the impact of next-generation products (NGPs) on the growth rate of Philip Morris and other tobacco companies. Considering that NGPs account for ~2.5% of BAT’s revenue (versus 13% for Philip Morris), we viewed that share price move as an over-reaction.
- US government bond yields have stabilised at around 3% as the world adapts to the end of the cheap money that has characterised much of the past decade.
Over the past few months, with more rational growth expectations for NGPs, the market has returned its focus to the stability and predictability of tobacco companies’ earnings. As BAT delivers each set of results in line with expectations, we expect the market to reward the group’s combination of high barriers to entry (it’s hard to build a competing brand in an industry where advertising is prohibited), steady margin expansion and predictable earnings growth of around 7% per year in GBP over the medium term.
At the same time, some of the shine has come off the global tech sector, to which most South African investors are exposed via Naspers’s stake in Chinese internet giant Tencent.
In a world of uncertainty, there is reassurance (from an investor’s perspective) in knowing that BAT’s customers will likely remain as addicted to their simple product tomorrow as they are today. Although fashion, tastes and technology will change, these changes remain slow and manageable. BAT’s returns should remain uncorrelated to both the emerging market tech sector and South African shares in general, thereby creating more stable portfolio returns for investors.
A boring business, delivering predictable returns and making portfolio returns less volatile, is just what the doctor ordered.
