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Corporate redemption for Big Tobacco?

Redemption comes along regularly in Hollywood – or, at least, in the output of Hollywood’s major industry – rather less so in real life and perhaps not at all in that branch of real life we call ‘business’.

Not that it’s for want of trying. Go to the website of almost any listed company – and certainly those of the FTSE 350 index – and you will find an outpouring of confected virtue. Words such as ‘sustainable’, ‘stakeholders’ and ‘responsible’ figure prominently, while information about what the company does will be harder to find. It’s as though companies are too often ashamed of how they make money.

In the case of tobacco companies, that would be understandable even if not completely fair. After all, in a tally of human misery, arguably drinks and gambling companies do more harm than smoking. Despite that, tobacco companies are judged the business world’s pariahs – what they do is legitimate, but just wait until tax revenues from smoking shrink to marginal significance.

Therefore, nowhere is the need for corporate redemption greater than in the tobacco business and nowhere is the road to redemption being travelled more daringly than at Big Tobacco’s biggest beast, Philip Morris International (US:PM), with its £900m agreed offer for Vectura (VEC), which supplies drug-delivery expertise for inhaled medicines. The irony screams out; not so much the poacher turned gamekeeper as the poisoner turned physician.

The response from healthcare trade bodies and the like has been predictably toxic – falling over themselves to establish a safe distance from a company that may soon be owned by the maker of the world’s top-selling cigarette brand, Marlboro, also known as the ‘cowboy killer’. The implied threat is that, if Vectura becomes a part of Philip Morris, its employees will be as welcome as a chain smoker at the annual conference of Asthma UK.

However, is this fair or even sensible? That Philip Morris is acting legally in bidding for Vectura is hardly in doubt. Sure, Big Tobacco’s defence of smoking was often as unethical as business could be and Philip Morris’s predecessor company played a leading role in the nastiness. But that was then and now Morris is paying the price in healthcare settlements. Meanwhile, its bosses seem determined to transform their group and, in doing so, they might push lots of development capital Vectura’s way.

In a letter to Vectura’s employees, Philip Morris’s new chief, Jacek Olczak, says: “It may come as a surprise to many of you that Philip Morris is evolving into a broader healthcare and wellness company.” That is a surprise indeed; it could be more accurate to say Philip Morris will take its first step towards being a healthcare company if its offer for Vectura is successful. The company’s focus is on so-called ‘reduced-risk products’, which means vaping rather than smoking, where consumers get a nicotine hit but with fewer risks. Hence Philip Morris’s pledge to generate more than half its sales from smoke-free products by 2025. Currently, they produce $6.8bn (£4.9bn) out of $28.7bn, or 24 per cent, but sales from conventional tobacco products are trending downwards, and in 2020 were 14 per cent lower than in 2018. Management aims to generate at least $1bn revenue – also by 2025 – from what it labels ‘Beyond Nicotine’. Thus the offer for Vectura would add $0.3bn to that target, but probably more in terms of credibility. At a price of less than 1 per cent of Philip Morris’s equity market value, it is hardly a big gamble.

In big tobacco’s race to be virtuous, Philip Morris seems to be winning. Or at least its share price has skinned the other members of Big Tobacco. At $98.40 it stands at 80 per cent of its 10-year high and has gained 29 per cent in the past 12 months. The next best performer is British American Tobacco (BATS), whose stock price is 61 per cent of the 10-year high at £27.69 and has gained 14 per cent in the past year.

How Big Tobacco compare
 Profit margin (%)Return on capital (%)Cash flow return (%)PE ratioPrice/salesDiv Yield (%)Payout ratio (%)
Philip Morris Inter'l42.055.161.816.14.54.992
Altria Group52.832.926.
British American Tobacco44.
Imperial Brands18.716.922.
Japan Tobacco20.711.815.412.01.86.088
 Mkt Cap ($bn)Share price*% 10-yr highCh on 1 yr (%)3 yrs (%)5 yrs (%)Non-tobacco sales (%)
Philip Morris Inter'l153,36098.4802918-124
Altria Group87,88747.56114-18-312
British American Tobacco87,37527.69492-29-426
Imperial Brands20,42015.73813-45-613
Japan Tobacco39,1082,157.54412-28-4911
* share prices in local currencies; all financial data, latest full year. Source: FactSet

Perhaps that’s as it should be since the proportion of Morris’s revenue derived from so-called non-combustible products far outstrips its rivals and the same could be said of its profitability ratios, such as profit margins and return on capital. True, this is reflected in its share rating, which is the highest among Big Tobacco, although the 4.9 per cent dividend yield on Morris’s shares is still substantial. That’s important since, given the uncertainties, shareholders need to be confident of taking something from their investment and that scale of income return is more than halfway towards an acceptable total return, even though the payout is barely covered by accounting earnings. Makes you think that a redemption of sorts might even be possible for bits of Big Tobacco, at least for investors.