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FTSE 350: Tobacco giants bet big on next-generation products

Tightening regulation is forcing tobacco companies into next generation products
January 24, 2019

Cigarettes are slowly going out of style. Decades of tightening regulation, from workplace bans to increasing age restrictions – and, more recently, plain packaging – have taken their toll, steadily pushing down the number of smokers year after year and casting doubt over the future of the big tobacco companies.

In response, British American Tobacco (BATs) and Imperial Brands (IMB) are moving heavily into 'next-generation products' (NGPs), such as tobacco heating products and vapourisers, even cannabis. The question investors face is whether they can move quickly enough to protect their generous dividend payments.

Use of e-cigarettes has grown both in the UK and internationally in recent years, but the notion they might one day replace cigarettes in terms of popularity looks fanciful. Data from the Office for National Statistics has shown roughly 5.5 per cent of people considered themselves ‘vapers’ in 2017, up from 3.7 per cent in 2014. This growth is encouraging, as Public Health England has found vaping poses a small fraction of the risk of smoking.

But in spite of the higher risk, cigarettes remain much more popular. ONS data found 15.1 per cent of the UK population were smokers in 2017, even as levels drop from year to year. What’s more, data from Action on Smoking and Health has shown a rapid decline in the year-on-year growth rate of e-cigarette use, dropping from 86 per cent in 2013 to just 4 per cent in 2017.

Investors will be keenly awaiting British American Tobacco’s full-year results for 2018, which are due to be released at the end of February. The group initially aimed to generate revenues of £1bn from its next-generation products in the year, but this was revised down to £900m last October due to stock reductions in Japan and product recall in the United States. Despite these challenges, management has reiterated their commitment to paying out at least 65 per cent of earnings as dividends.

Imperial Brands has been pushing its Blu vapouriser brand internationally, launching in France, Germany, Russia and Canada, among others, in 2018. More launches are planned in 2019, although the group’s NGP business remains a small part of its overall operation, with £200m in sales in 2018, just 2.6 per cent of the tobacco and NGP division’s revenues.

The group has also diversified into the burgeoning cannabis market with an investment in Oxford Cannabinoid Technologies. This is a growing market, with Canada announcing full recreational legalisation and the UK making it legal for doctors to prescribe cannabis-based medicines. If this trend continues, we can expect to see cannabis emerging as another potential alternative to declining tobacco sales, making further investments likely.

 

NamePrice (p)Market cap (£m)12-month change (%)Trailing PEForward PEDividend Yield (%)Last IC View
British American Tobacco2512.557630.99-49.788.687.77Buy, 2,786p, 12 Dec 2018
Imperial Brands239922952.11-21.928.88.47.83Buy, 2,631p, 06 Nov 2018