Saturday, January 4, 2014

A tale of 2 British American Tobaccos

Please read the disclaimer here:http://greedydragoninvestment.blogspot.com/p/about-greedy-dragon.html. Enjoy the article, bitches!


In this article, I will be comparing British American Tobacco (BAT) Malaysia against BAT PLC to see which should make the better investment. BAT PLC trades on the London Stock Exchange; the stock closed at 3,200 Pence or 32 Pounds on Friday. BAT Malaysia trades on the Bursa Malaysia; the stock closed at Ringgit Malaysia 63.88 on Friday. Both companies make tobacco products which include Dunhill cigarettes. While BAT Malaysia mainly engages in making tobacco products for the domestic market, it also engages in contract manufacturing for the export market. BAT PLC has operations worldwide. The companies will be judged based on the following criteria: profitability, valuation, returning capital to shareholders and “other stuff”.  I personally don’t smoke or drink. Cheeseburgers, video games and being a badass investment analyst are enough to make me high on life. Anyway, enough of the small talk, let’s get down to business.

Profitability

BAT PLC managed to increase prices to offset decline in product volume. BAT PLC’s revenue (excluding duty, excise and other taxes) and operating profit for the 6 months ended June 30, 2013 grew by 1.61% and 3.12% year-on-year respectively.

BAT Malaysia managed to increase prices and increase its contract manufacturing volume to offset decline in domestic product volume. BAT Malaysia’s gross profit and operating profit grew year-on-year by 0.64% and 4.55% respectively for the 9 months ended September 30, 2013. For BAT Malaysia, I calculated gross profit growth instead of revenue growth as I think the third quarter report presents the gross revenue figure (which includes excise payment). 

Both companies earn amazing returns on capital. BAT Malaysia generated annualized return on equity (ROE) and return on assets (ROA) of 165.01% and 56.15% respectively for the 9 months ended September 30, 2013. For the 6 months ended June 30, 2013, BAT PLC earned annualized ROE and ROA of 60.23% and 15.70% respectively. I seriously got a hard-on calculating the ROE and ROA for both companies. Unfortunately, both companies are at the stage where they’re returning most of their earnings to shareholders as there aren’t many opportunities to reinvest profits. Overall, I would say that both companies are on even footing when it comes to profitability.

Valuation

If you annualize BAT PLC’s diluted earnings per share of 106.1 Pence for the 6 months ended June 30, 2013, the stock would have a Price/Earnings ratio of 15.08. After you annualize BAT Malaysia’s earnings per share of Ringgit Malaysia 2.222 for the 9 months ended September 30, 2013, the stock would have a Price/Earnings ratio of 21.56. So in terms of valuation, BAT PLC is more attractive than BAT Malaysia.

Yes, I know that it’s better to use owners’ earnings/true earnings than reported earnings when determining whether a company is overvalued or undervalued. But both companies are in the maturity stage, so their reported earnings are close enough to their true earnings power.  Looking at the financial statements, I think true earnings would be plus-minus 5-10% of reported earnings if you used maintenance capex instead of depreciation and accounted for one-time items. I didn’t do the calculations for true earnings as I don’t think it would change the fact that BAT PLC is the cheaper stock (I was also busy watching people battle pokemon on YouTube).

Returning capital to shareholders

In the past 12 months, BAT PLC paid out/declared a total of 137.7 Pence per share in dividends which give the stock a dividend yield of 4.30%. BAT PLC also spent 641 million Pounds buying back stock. As BAT PLC’s shares are trading at a reasonable valuation, I think the company creates value for shareholders when it buys back its shares. If you count share buybacks as a form of dividends and assume that the company bought back 1.25 billion Pounds worth of shares in 2013 (the same amount it spent buying back shares in 2012), then BAT PLC’s effective dividend yield would be 6.33%.

BAT Malaysia paid out/declared Ringgit Malaysia 2.81 per share in dividends in the past 12 months which gives it a 4.40% dividend yield. Both BAT Malaysia and BAT PLC return almost all of their profits to shareholders, so they both score well in this criterion. However, BAT PLC returns more capital to shareholders as a percentage of its share price due to its lower valuation.

Other stuff

BAT PLC has lower geographic concentration risk than BAT Malaysia. BAT PLC’s profits are well-diversified geographically. The following is the geographical breakdown of BAT PLC’s operating profits:

Asia Pacific
29.71%
Americas
25.32%
Western Europe
18.56%
Eastern Europe, Middle East & Africa
26.39%

While BAT Malaysia has experienced healthy growth in its contract manufacturing business, it still heavily relies on Malaysia for its revenue. Geographical diversification is especially important for the tobacco industry. This is the case as a country’s government might increase excise on tobacco products by a large amount and unintentionally drive smokers to buy illicit cigarettes to get their fix. Now, I think the environment in Malaysia is still ok for tobacco companies to make good profits. But if all other things were equal, I think BAT PLC with its global operations is a safer bet than BAT Malaysia.     

According to Deloitte’s list of withholding tax rates for 2013, both Malaysia and the U.K. do not levy withholding taxes on dividends. You can view the list here. I’m not a tax expert, and I don’t know how your respective governments might treat foreign dividends.



Overall I think BAT PLC would make the better investment. I have no intention of investing in either stock. But if a family member asked me to construct a retirement portfolio for her, I would probably allocate a small part of the portfolio to BAT PLC. I think BAT Malaysia is a bit overvalued. Thank you for staying with me throughout this article. If you’re a smoker, do light one of those sons of bitches up if you liked this article. If you’re a non-smoker, then don’t fucking smoke as it’s bad for health (I guess that’s the responsible thing to say). Take care and stay rational!

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