BAT gets smoked on JSE over menthol
Shares in the tobacco multinational are now at a multiyear low, reflecting fears about the impact of new rules
The potential ban of menthol cigarettes in the US pulverised the share price of British American Tobacco (BAT) this week. On the JSE, BAT’s share price haemorrhaged 11.3% on Monday — wiping R174bn off the market value of SA’s largest listed company, after AB InBev.
It was equally brutal for BAT in London, where it is also listed. But the impact was more muted for Imperial Brands, maker of Davidoff, West and Gauloises (which lost 4%), and Altria, maker of Marlboro (which lost 3%.).
But investors needn’t panic, say analysts: such a ban would involve making a tricky distinction, as menthol cigarettes are factually no more harmful than ordinary cigarettes. To ban them, then, would be difficult to justify scientifically.
The US Food and Drug Administration (FDA) is arguing that menthol cigarettes make it harder to stop smoking, so they pose a greater health risk than regular cigarettes. The irony is that they are harder to quit because they taste better, or at least they don’t feel as "raspy" on your throat. But that has another effect: people tend to smoke more of them, and young people tend to smoke more menthol cigarettes.
But this is precisely why BAT has made a point of buying menthol brands in recent years. In 2015, for example, BAT’s US subsidiary acquired the Newport brand, the largest-selling menthol brand in the US.
The purchase meant BAT’s reliance on menthol cigarettes has bumped up substantially, and menthol cigarettes now constitute about 25% of its profits. About half of its US profits comes from menthol cigarettes.
All of which means that analysts believe that of all cigarette companies, BAT is the most exposed. The market agreed, which is why the share price got hammered.
Investec analyst Eddy Hargreaves says the question of whether there is scientific backing for a ban on menthol cigarettes is not just a philosophical nicety. The FDA is legally required to act both in the interest of US consumers and "with the backing of scientifically robust evidence", he says.
"The FDA has periodically, over the past several years, considered taking action against the marketing of menthol cigarettes. However, it has lacked the scientific evidence that it needs to proceed with any action," says Hargreaves.
One interesting aspect of menthol is that its popularity skews to a poorer demographic, so any restriction would have political ramifications. At the same time, the FDA is also trying to limit the use of flavoured e-cigarettes which may appeal to minors, and action on that is expected by the end of this month.
Surprisingly, Hargreaves says, menthol-flavoured e-cigarettes are not on the FDA’s list.
In its response to the FDA announcement, BAT kicked for touch. The multinational said it was "not aware of anything that has changed to suggest the FDA would deviate from its existing multi-year, comprehensive rule-making process on flavours in tobacco products, which includes menthol".
In other words, if it happens, it’s going to take a long time.
"We believe the evidence shows that menthol does not encourage people to smoke, make smoking harder to quit or increase the risks to health compared to cigarettes without menthol," said BAT’s group head of corporate affairs Simon Cleverly.
That may be so, but sentiment is against the company, with a new threat to ratchet up the rules seemingly just over the horizon. It has meant that BAT’s share price has taken a fearful hammering this year — down 40%, the biggest drop in at least two decades.
It seems this may have been too harsh a reaction. If the company was making less money, it might be justified — but despite a small mountain of regulatory issues, BAT continues to be hugely profitable and its revenues are still edging upwards.
Over the past decade, BAT’s revenues have nearly doubled, from £12.1bn to £24.5bn, and its margins continue to expand.
History is also on its side. Only twice in the past 19 years has BAT suffered an annual share price decline, and it remains a highly recommended stock by analysts mainly because it is still making bucketloads of cash. Of the 22 analysts who follow the stock, 15 rate it a "buy" or "outperform" and only two suggest selling the stock.
But this time, there may be more to worry about. Doubts are creeping into the market about whether young people are starting to prefer other products — particularly vaping and maybe even (now legal) marijuana.
Perhaps to rise with the tide, BAT is itself expanding into vapour and heated-tobacco products, but there’s no hiding the fact that its business is still overwhelmingly linked to cigarettes.
Smoking hot it is not.