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Daily Intelligence Briefing

Wednesday, December 6, 2023

Identifying Change-Driven Investment Themes

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

British American Tobacco Writes Down Cigarette Brands, Preps to Account for End of Traditional Combustibles Era

Summary: British American Tobacco (BAT) has disclosed a multi-billion dollar impairment affecting its portfolio of US cigarette brands. BAT will also amortize these brands from 2024 on, becoming the first major cigarette distributor to enact an effective expiry date on its combustible tobacco business. Legislation meant to cut cigarette consumption is becoming more aggressive in the US and beyond.


BAT will now embark on a strategy to derive half of its revenues from non-traditional cigarettes by 2035. Thus far, strategies enacted by big tobacco firms to replace declining cigarette sales have yielded mixed results. Recent acquisition activity indicates a shift toward the cannabis business will form a key plank of British American’s strategy going forward.


Related Stocks: British American Tobacco p.l.c. (BTI), Altria Group, Inc. (MO), Philip Morris International Inc. (PM)

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In the latest blow to big tobacco valuations, British American Tobacco (BAT) – the third-largest tobacco product distributor in the world – is taking a massive non-cash adjusting impairment charge of -$31.5 billion on its widely-recognizable portfolio of US cigarette brands. The owner of Camel, Newport, American Spirit, Lucky Strike, Pall Mall, and other labels is taking steps toward a new strategy that will attempt to shift half of their business toward non-traditional cigarettes by 2035. Chief Executive Tadeu Marroco noted that it was no longer possible to justify an indefinite value for its cigarette brands equating to around $80 billion on BAT’s balance sheet.


BAT appeared resistant to this course of action until recently, holding fast to cigarettes while competitors Altria and Philip Morris shifted toward a slate of alternatives. These products, which range from vaporizers to heated tobacco devices, have delivered mixed results thus far, but still seem to have better fortunes ahead of them than the traditional cigarette business.


Shares of tobacco purveyors across the board fell on Wednesday morning in the wake of BAT’s cigarette write down, compounding year-to-date declines at Philip Morris, and Altria. For its part, British American Tobacco has slumped by nearly -30.0% this year. A particularly steep decline took hold of the company in the wake of a $635 million penalty issued to the company by US authorities as part of a settlement last April. BAT admitted that it circumvented long-standing sanctions and sold tobacco products to North Korea between 2007 and 2017.


It’s no surprise anymore that cigarette sales are likely in a terminal decline; a trajectory that was set in 2019 when the number of male tobacco smokers around the world began to decline for the first time on record. BAT noted that, in addition to the immediate impairment, the company would start amortizing the remaining value of its US combustibles brands in 2024, making it the first of the major cigarette players to acknowledge that its tobacco brands’ value has an expiry date. The pressing questions that now need to be addressed by firms in the tobacco industry is how quickly the decline will take hold and what strategies are being employed to revitalize the sprawling enterprises built by cigarettes and similar tobacco products. MRP has highlighted these efforts in depth throughout several previous Intelligence Briefings.


In the UK, where BAT is based, the declining market for cigarettes could soon be impacted more directly by aggressive legislation. Prime Minister Rishi Sunak has announced a plan to raise the legal age to buy tobacco products (currently set at 18) by 1 year per annum starting in 2027, effectively phasing out the ability of the next generation – and all subsequent generations – to purchase cigarettes. The Lancet notes that New Zealand has already introduced a similar law, barring young people born on January 1, 2009, or later from ever legally buying cigarettes or any other tobacco products.


New data from the FTC shows that the number of cigarettes that the largest cigarette companies in the US sold to wholesalers and retailers decreased from 190.2 billion in 2021 to 173.5 billion in 2022. About 11% of adults told the CDC last year that they were current cigarette smokers, according to the latest preliminary data from the National Health Interview Survey, down from 15.5% in 2016.


Big tobacco did receive somewhat of a reprieve in the American market recently, after it became clear that a coming ban on menthol flavored cigarettes would likely be pushed back into 2024. The Food and Drug Administration (FDA) missed an August deadline it set to complete a rulemaking process for the ban. Per the FTC, menthol flavored cigarettes comprised 36% of the market among major manufacturers in 2022. Though it may be dragging its feet on the eventual menthol ban, the administration is continuing to expand its attempts to crackdown on cigarette smoking, fighting in court to require new graphic health warnings on cigarette packaging. The labels, which include 11 images that illustrate the risks of smoking, were struck down by a lower court last year, but Reuters notes that the FDA is continuing to make their case in the Fifth US Circuit Court of Appeals.


Several BAT acquisitions and developments over the past few months made it increasingly obvious that the company was set to begin shifting away from traditional cigarettes. In particular, purchases in the cannabis business may hint toward a post-cigarette strategy that focuses on the burgeoning marijuana and CBD industries. In April, BAT invested $10.0 million in partnership with CBD firm Charlotte’s Web to pioneer a hemp-derived drug for an undisclosed neurological condition that the firms will seek FDA approval for. BAT previously invested $56.8 Million directly into Charlotte’s Web, gaining a 19.9% stake in 2022. BAT expanded its ambitions in cannabis by upping an existing ownership stake in Canadian cannabis producer Organigram Holdings, injecting $92.5 million to expand its overall equity interest in the company to 45%. Prior to this latest investment, BAT had already spent $166.9 million consolidating its ownership in Organigram.


Last year, MRP highlighted groundbreaking survey results from Gallup, which found that more Americans openly admitted that they smoke marijuana (16%) than those who say they’ve smoked cigarettes in the past week (11%). That was the first time the popularity of cannabis had exceeded cigarettes in the recurring survey that Gallup has been conducting since 2013. 


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