BAT turnaround impressive
By Admire Mavolwane
“I TOLD my minister that in regard to health principles certainly we must be seen to be together with the rest of the world. But we also have economic principles to take care of.
When we were growing up, our parents, our mothers (certainly, my mother), and our teachers forbade us to smoke. But one thing they never said was: ‘Don’t sell tobacco’. If we sell it and others smoke it, is there anything wrong? If we sell it, we must grow it as well. It is our industry and we must support it”.— Then Prime Minister Robert Mugabe on whether Zimbabwe would join those who discourage tobacco growing and smoking.
British American Tobacco (BAT) was established in Zimbabwe in 1920 and listed on the Zimbabwe Stock Exchange in 1959. In May 2000, the company merged with sister company Rothmans of Pall Mall. Rothmans of Pall Mall was established in Zimbabwe in 1960 and listed on the ZSE in 1961.
The company is purely a Zimbabwean cigarette company producing mainly Zimbabwean brands Madison, Kingsgate, Newbury, Everest and Berkeley. Although the international portfolio of BAT Plc includes brands like Peter Stuyvesant and Dunhill, these are not part of the BAT Zimbabwe portfolio.
The flagship brand is Madison, which is a “heavy” cigarette favoured by new smokers and comprises the bulk of volumes. Kingsgate is the premier brand, but production was scaled down following the economic downturn. Everest and Berkeley are next in line in terms of contribution to volumes.
BAT exports at the most comprise 10% of revenues. The company exports limited volumes of Kingsport to Mozambique and Angola. The company also manufactures limited volumes of Peter Stuyvesant and Dunhill. A fair amount of cut-rag tobacco is sold to Fabrica D Cigarros De Manica Limitada, a BAT Plc subsidiary in Mozambique.
The smoking gun
BAT is an agro-processor, turning locally produced and cured tobacco leaf into cigarettes. Thus its fortunes are closely linked to the tobacco crop output. BAT came out ahead of competitors such as Aico, Seedco, Hippo as a result of good annual share price performance, obviously benefiting from the share’s illiquidity. In fact, the BAT story is more of a turnaround than anything else. A move from loss to profit made the day for the company.
On the back of 49% growth in volumes, with the iconic Madison brand achieving a 61% increase in sticks consumed, net revenues increased by 74% to US$40 million. During the year, BAT pushed in a “modest” price increase of 40%, which also impacted on revenue increase.
In 2011, the company invested in a new cigarette maker and packer, resulting in much improved product quality and factory efficiencies. Consequently, gross profit margins improved from 31% to 46%. Correspondingly operating margins improved from 1% to 18% resulting in operating profits of US$7 million. As a result the picture changed dramatically, from loss to a profit. In line with BAT policies worldwide, the company paid out a dividend of US0,16/share which comes out to a generous payout ratio of 93%.
The outlook is promising for BAT, with the company re-introducing 10s packs coupled with an enhanced focus on distribution. The company expects tobacco consumption to improve as the economy and real earning power improves. In previous years, particularly around 2005, tobacco consumption per capita was growing at about 2% per annum, whilst GDP was in decline. Once GDP starts to grow rapidly, per capita consumption is also expected to increase.
According to the World Health Organisation, the percentage of smokers in the over 15 years adult population is in the 30-39% range for Zimbabwe, which is quite low compared to other African countries averaging 47%.
What has BAT working for it?
The following factors add impetus to BAT:
Litigation: Unlike in the developed world, there are no litigation worries in Zimbabwe. The authorities — particularly the health departments — are more pre-occupied with HIV/Aids compared to issues such as lung cancer and carcinogens. The company does not even have a “litigation reserve/provision” on its balance sheet. As such BAT Zimbabwe does not have the normal “death merchant” tag attached to companies like Philip Morris in USA.
Thus, unlike overseas markets, there is no need for an inbuilt “litigation discount” on the stock.
- Implicit government support: Unlike other governments which do not encourage smoking, the Zimbabwean authorities have left that decision to the individual.
- Annuity income: Tobacco business is similar to other forms of annuity businesses. Once a smoker gets hooked, then an annuity income stream has been established. There are more new smokers than quitters.
Furthermore, it is not costly to manufacture a cigarette, hence margins are good. And there is fantastic brand loyalty which guarantees an annuity income flow until the smoker either quits or passes on.