It would be no surprise to anyone to learn that cigarette consumption in the UK has fallen over time. But on looking at the numbers in the last 100 years, I found the extent of decline striking. From its peak of 9.5 per day in 1973, the number was down to three a day by 2014, less than a third of what it was at its height, according to World Bank data. A similar trend is visible for the US as well. This has implications for tobacco companies, which are now facing declining sales volumes for cigarettes and are looking at next-generation products (NGPs) to cater to the rising demand for cleaner, healthier products.
New investments, growing revenue
The manufacturer of Davidoff among other labels, FTSE 100 share Imperial Brands (LSE: IMB) is one of those making inroads into the burgeoning NGP market. It recently invested £75m in Canada’s Auxly Cannabis Group, which will allow for development of new products. This follows its investment in Oxford Cannabinoid Technologies last year. And its returns from NGPs are showing. Even though they are a minuscule part of overall revenue, it expects to deliver 245% growth in the segment in FY19 (year ending September 30).
In the meantime, IMB’s performance from traditional tobacco products stays strong. As per the half-year update, it showed both revenue and profit growth. It’s also quite confident of future performance, stating that revenues will be “at, or above, the upper end of our 1%-4% revenue growth range” for the full year. I think it’s worth flagging though, that the company recently announced the dividend policy will be flexible in the future after having committed to 10% growth annually for the past few years. As long as it’s beneficial to the company’s financial health though, this need not be a source of disappointment for shareholders.
Sluggish share price, attractive bet
Its price-to-earnings (P/E) ratio is at a relatively muted 13.2x, slightly higher than its peer British American Tobacco, which trades at 12.1x. But these aren’t high multiples compared to a number of other FTSE 100 shares. I think the reason for this is clear — tobacco shares have underperformed. At the time of writing this article, the share price was almost 40% less than the highest level seen over the past five years.
But share price falls were expected on regulatory changes and on changing tastes towards NGPs over the past few years. In fact, I had pointed out that these dips need to be braced for in an earlier article as well. The times they are a-changing. And if the transition into NGPs goes well, even with a softening in traditional tobacco usage, there’s much for shareholders to look forward to. Tobacco is also a good defensive investment in potentially uncertain economic times. For those of us who keep a keen eye on macro risks, this itself makes it a good investment.