Asset Class: US Stock / International Stock (Sector: Consumer Staples / Industry: Tobacco)

Original Investment Thesis (9/2019): I have been looking for a Consumer Staple company to add to my holdings. The tobacco industry has been underperforming recently and is very attractive from a valuation perspective due to a great deal of recent bad news. After kicking myself for decades for not owning this name I finally pulled the trigger.  The company appears to have a lot of debt, but upon closer review, it is extremely manageable.  I believe that e-cigarettes and cannabis will be a huge path to growth for this company. MO and PM are in merger talks and I think they will ultimately merge.  I want the combined companies regardless so I bought half of each just in case they don’t wind up merging. If not, I’ll just keep both (which might even wind up being better long-term).

Current Thoughts (9/22/2019): Long term holding.  There is a ton of bad news flowing currently on the e-cigarette front that is really impacting the price. I expect all this news (and subsequent regulation) to ultimately benefit MO/PM (and decrease competition). 

After watching it for 2 decades I’m finally buying Altria $MO today!

September 2018

Here is a PDF with my analysis if you’d like to see what I look at: 

Back in the late 1990s when the cigarette companies where all being threatened with massive judgments against them (and then did ultimately receive them) their stocks got pummeled.  I have kicked myself for not buying $MO back then for almost 2 decades.  If I had done what I was about to do at the time I wouldn’t be working today.  Back in December 2018 I was again watching closely and got close to pulling the trigger on investing in $MO again.  I didn’t do it and was kicking myself later when the price bounced back higher.  I’ve talked about it with my son a lot since then (each time becoming more and more convinced there is good value in this company).  When the stock popped on merger talks a few weeks ago and then quickly dropped my sense of urgency was raised.  Since then the stock has dropped back below those December 2018 levels and this time I’m going in!  I’m betting they wind up merging with $PM Philip Morris.  Just in case they don’t, I want to own the whole rather than one or the other.  I’m going to split this single position into two mini-positions and purchase each equally.  They are two different companies but, in my opinion, not really…and also, in my opinion, won’t be two different companies for much longer.  I’ve been looking for the perfect consumer staple stock to add to my portfolio and this is it in my opinion.

Something like 1 in 7 people on earth smoke (15% of the population).  That is a billion-plus people!  They do this despite knowing it is not good for them.  Back in the late 1960s when you could smoke everywhere (hospitals/airplanes?!?) over 40% of the population were smokers.  Smoking is down in the US over the past decade…from 21% to 15%.  Worldwide it is not down as much.  This is a pretty dramatic swing down in usage for sales to have remained almost flat during the same period.  I read somewhere that the number of cigarettes sold in the U.S. from 2001 to 2016 declined 37%, but this was more than made up by the greater than 70% increase cigarette prices.  So, from a demand standpoint their core product is in decline no question.  Regardless, they have an enormous market and one I believe that will always remain a very large market.

From an investor’s standpoint, I read that from 1926 to 2015 the tobacco industry has never had a negative rolling 10-year period return.  The tobacco industry is the second worst-performing industry (out of 70) over the past year (down almost 21% with $SPY up 3%).  2nd worst over the past 3 years too (down almost 29% with $SPY up 40%).  It hasn’t been a great decade either $SPY is up 185% and the tobacco industry is only up 96%.  So, no question tobacco is on the ropes right now.

So, tobacco companies are all doomed and going to go out of business…right?  Not so fast!  The top couple of tobacco companies (there are only like 7 of them) account for 90+% of the industry’s revenue.  That’s right, 7 companies sharing a little over 1 billion smokers worldwide.  I read somewhere that $MO holds more combustible cigarette market share than the next 7 brands combined.  There are also tight regulations on the industry (which give those incumbents a wide moat).  Their markets may be shrinking…but no one will be able to take their markets away from them…probably ever.  Hell, these companies can’t even advertise…how would an upstart even get their products to market (if they too can’t advertise)?!?  I read somewhere that in 2016 the industry produced 2.27 trillion cigarettes per year are produced by the industry (300 for every person earth) for $150 billion in sales a year.  Not small potatoes.  I would imagine other companies would want to get in on that, but they haven’t.  I believe they also won’t (and won’t be able to).

In my opinion, tobacco isn’t going away…EVER.  Nothing much has changed in the core product for 100+ years.  The only thing that has changed is the regulation of the product and awareness of the health impacts.  BUT…now they have figured out there are two new growth engines that fit nicely within their existing framework.  They also believe (and many others believe) that these new growth engines are not as bad for you as their current products!  Oh boy…this is exciting for me to say the least.  So, they’ve weathered a tremendous, long-term, decline in the burned tobacco market.  Now they are starting aggressive investment in potential growth industries (heated tobacco and cannabis).  Imagine how well they’ll be able to market/sell a product that is less harmful to you (than one that is basically proven to shorten your life)?!?  The commercials have already started on television. 

  • [paraphrased] Switch to e-cigarettes and your life will be so much better.  Welcome to nirvana!
  • [paraphrased] Did you quit smoking because you thought it was unhealthy…great…now you can use e-cigarettes and smoke again without all the imminent death worry?!?  Join in! 

Imagine if they were somehow able to convince that 40% of the population that used to smoke that it is okay for them to smoke again?!?  All this and cannabis hasn’t even really gotten going yet.  Does anyone know someone who smokes weed that argues that it is ‘actually good for them’ and ‘way better than smoking’?  I thought so!  I don’t know about all that but I know that it is a massive market/industry that is barreling toward legalization on a large scale.  With legalization will come regulation.  You manufacture it and smoke it…looks a lot like tobacco to me!  I wonder if there is a company in a similar space that knows about tobacco regulation?!?!  Hmmm!?!?

They just purchased (in Dec 2018) a large stake (35%) in Juul for $12.8 billion.  At the time Juul had around $2 billion in revenue and this investment gave the company a near $38 billion valuation.  Rich investment valuation for sure!  Juul had a 72% market share in the US e-cigarette market (in 2017).  Altria has stated this investment is already growing quickly since its purchase.  Imagine if $MO became the market share leader it is within tobacco in the e-cigarette industry.  In the same month (also Dec 2018) they also purchased a large stake (45%) in Cronos for $1.8 billion.  Cronos is potentially a leader in the cannabis industry.  For those under a rock somewhere, there is a tad bit of excitement about the prospects of the cannabis industry.  Imagine if $MO became the market share leader it is within tobacco in the cannabis industry.  Now name a company on the planet who knows what they know about how to make both these things happen.  Not too many names come to mind.  Juul and Cronos (along with Altria) might just be the partnership to make it happen.

Not to mention the little e-cigarette devices look cool.  To me, they are like the iPhone was to regular cell phones back when they rolled out…except for cigarettes.  They sell the device and then have a recurring stream of revenue by selling the ‘pods’.

Regulators (worldwide seemingly) are causing issues with e-cigarettes and cannabis…my guess is $MO knows how to deal with regulators (and much better than others).  So, if anyone can navigate these waters it is them (and maybe them alone).  I think young Juul and Cronos found an excellent partner in Altria.  I guarantee that if these initial investments work well these companies will be wholly owned soon enough.

They paid high valuations for the recent investments they made.  The investment in Juul was “by far the biggest investment ever in a U.S. venture-backed company.”  But to me they make sense.  They can basically replicate every single tactic they’ve used for decades in both these industries (and both industries have massive potential).  To me, it looks like being able to get in on Philip Morris back when it was just getting started…except now they know how to do it all (marketing, work with regulators, finance the business, crush competitors, etc.).  I wouldn’t want to be in their way. So, if anyone is going to ‘overpay’ for a deal…it should be these guys.  My guess is these will wind up being great investments for them (mainly because it is them making it).  I also think they know how to make deals work…the art of the deal!  These guys know how to do huge deals it is part of their DNA.

  1. In 1985 Nabisco merged with RJR Tobacco (unrelated sort of). In 1988 Philip Morris bought Kraft.  In 2000 Philip Morris purchased Nabisco (and rolled it into Kraft).  They then took Kraft public in 2001 and spun off their remaining shares of Kraft in 2007.  That business (the combined Kraft/Heinz) is in the toilet now so I guess that was a decent idea.
  2. They purchased UST tobacco back in 2009 for $11.7 billion.  Smokeless is now one of its most profitable products.  This has been a good deal and fits perfectly with their existing businesses.
  3. They just made substantial investments in two companies in late 2018.  These would appear to be richly valued except that they line up as well (maybe even better) than the UST deal did.  Why better?  Because these two industries are new and have enormous potential.
  4. They are also in merger talks with Philip Morris International as we speak. This is the same company they spun off back in 2008.  Philip Morris has the faster-growing international markets while Altria has the slow/no growing US market.  They each have e-cigarette businesses.  Altria is working with Juul and has the rights to sell Philip Morris’ IQOS device in US.  This smells of a ‘heads I win / tails I win’ in the US market.  Merging the two companies would allow Philip Morris access to sell the very popular Juul worldwide.  This could translate huge if they can achieve similar market share in other countries as they currently have in the US.  Regardless of how all that plays out, the combined entity would have massive worldwide scale and power within the industry (just like they had over a decade ago before they split).

I’d like the stock to be a bit cheaper than it is right now but I’m not waiting any longer.  I’m entering positions with a 74% certainty rating.  The biggest things impacting my rating are the debt to equity (which after analysis is not a huge issue for me at all in reality) and the valuation.  The valuation isn’t absurd right now by any stretch of the imagination.  The stock trades at around $41 and I think $36 is what it is worth in my perfect price world.  At this point, we are close enough and I am excited enough about the potential for the company that I’m going to get this position open.  I suspect many years from now I will be glad I did. I’m sharing my analysis here.  If you have thoughts on it, I’d love to hear them hit me up on Twitter @joeydean72

Published by deanorolls

Well, if I told you that you wouldn't need to go to my would you?!?!

Leave a comment

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: