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Provided by the South African National Department of Health     


the sweet taste of sin

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David Lerche

Chief Investment Officer

Regulation 28 of the Pension Fund Act limits South African investors to holding no more than 30% of their retirement assets offshore. This is a less-than-ideal situation given the local market accounts for only around 1% of the global equity market. Fortunately however, we do have several dual-listed shares on the JSE that don’t count towards this 30%. Among these companies offering exposure to the global economy, our current favourite is British American Tobacco (BAT), due to its attractive valuation and exceptional history of profitability.

‘Rand hedges’ is the term often used to refer to dual-listed companies that earn most of their revenue offshore, such as BAT, Anheuser Busch and Richemont. Some also view resource stocks as rand hedges, but in our view, these companies’ fortunes are closely linked to those of South Africa. In general, low commodity prices are a driver of rand weakness, so such companies tend to underperform during periods of currency depreciation.

Among the companies that offer returns genuinely uncorrelated to the South African economy, our preferred choice at the moment is BAT, which offers attractive exposure to global consumers, with a tilt towards the US, the world’s largest and most profitable cigarette market.


Over the past 17 years, BAT has delivered more than 13% compound annual dividend growth in British pounds, increasing its dividend every year this century. This illustrates its ability to continually improve margins through operating efficiencies and market share gains, despite industry volume declines.

The group has completed the purchase of US business Reynolds International, which shifts its exposure towards a more profitable, less competitive market where it’s also the clear leader in the vaping space. US tax cuts provide an additional boost to future profits.

The next step for BAT is the move towards next-generation products (NGPs), including vaping and heat-not-burn products that offer customers their nicotine fix with a 95% reduction in harmful chemicals. Management expects NGPs to account for almost a fifth of group revenue in the next five years.


The group’s global scale in both distribution and manufacturing, coupled with its leading technology, position it well to migrate a large proportion of its cigarette customers to NGPs over the coming decade. In an industry where advertising is largely prohibited, BAT’s strong existing brands provide high barriers to entry.

Despite this, the market has lost its enthusiasm for ‘boring’ consumer staples companies in recent months as US bond yields have risen, reducing the relative attractiveness of such companies’ dividends. We see this as overdone.

In our view, BAT’s return on equity of more than 60% justifies a higher valuation than the current 14 times forward earnings, given the excellent conversion of accounting profits into cash. We expect earnings per share to grow by 9% per year in pounds for the next three years.

BAT trades at a free cash flow yield of more than 7% and offers a dividend yield of around 4.5% in pounds. This is attractive relative to the group’s own history, its tobacco peers and global consumer staples peers.

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