The US Food and Drug Administration has plainly learnt the lessons of the 1920s. The Volstead Act was passed in 1919 to ban the manufacture and consumption of alcoholic beverages. It was in place for 14 years, and it didn’t work. Prohibition was wildly unpopular, Americans continued to find drink somewhere and it fuelled the rise of criminal organisations such as the Mafia.
The FDA’s attempt, announced last Friday, to limit the use of nicotine is more measured. It talks of a “multi-year road plan” which analysts reckon could take as much as a decade to be implemented. It is the start of a long consultation process. There are measures to increase the number of so-called next generation products, vaping and “heat not burn” cigarettes that deliver the same nicotine rush but fewer toxins, that can come to the market.
These are being developed by almost all the big tobacco companies as an alternative to the cigarette, even if it is still early days to work out their ultimate impact on the bottom line. The FDA has a record of moving quite slowly and may not even achieve its aim of getting the amount of nicotine in cigarettes to “minimal or non-addictive levels”, whatver that means. The link between habituation and addiction is a complex one.
If companies are told to reduce the amount of nicotine to, say, half the current level, there is no guarantee this would fall within the parameters set out by the FDA. The possiblities for legal action in America are enormous.
Still, the FDA announcement sent prices plunging. Shares in British American Tobacco were trading at £53.22 on Thursday night. They hit £49.60 a day later and £47.13 on Monday, before a reconsideration of the implications sparked some recovery, and they ended up 118½p at £48.32 last night.
Imperial Brands, the other London-quoted company, stood at £34.46 on Thursday night, plunged to £31.20 at Monday’s close, and recovered 83p to £31.77 by tonight.
Investing in the tobacco companies has always been a balancing act between the dividend yields they can supply because of the strong cashflow from a market that does not require much capital spending and the fact that that market is declining, by some measures by 4 per cent or more in volume terms, and may be threatened by tighter regulation.
The general tone of analysts’ comments since the FDA announcement has been reassuring, reflected in that bounce from earlier lows. A note from Citi talks of a market overreaction. JP Morgan thinks the FDA propopsals may never happen for the above reasons.
Rae Maile, analyst at Cenkos Securities, says there is nothing in the proposals to suggest that those dividend yields are at risk. “Whatever the FDA does, smokers smoke because they enjoy smoking so there will be a continued demand for the product. That demand will be delivered by the legitimate industry to consumers who want it over time.”
Shares in the sector have been strong since the start of 2014 because of the attraction of such defensive yield stocks. This has meant those yields have come down. Before the FDA announcement BAT, the better regarded of the two, was yielding 3.4 per cent but the return now is 3.8 per cent. Imperial has gone from 5.0 per cent to 5.4 per cent.
BAT has increased its exposure to America by buying Reynolds American and will get about 43 per cent of its revenues from America. Imperial gets about 23 per cent. Reynolds is seen to be further down the route to developing those next generation products, which is an advantage. Further consolidation has long been rumoured, with Japan Tobacco seen as eyeing Imperial, but this looks implausible.
Those prices could bounce further as the market takes heart that the FDA proposals will come to little in the short term but there still seems better income elsewhere.
MY ADVICE Avoid
WHY The FDA proposals offer no short-term threat to investors in tobacco stocks, but the longer-term picture remains more uncertain
Intertek Group
The reputation of Intertek, one of the more unsung heroes of the FTSE 100, for dull reliability took a knock a couple of years ago because of the downturn in the oil and gas sector.
The company provides testing services in about 100 countries for products and goods being shipped around the world. Among these are checking on new infrastructure in oil and gas, such as refineries and pipelines, and this sort of capital spending has largely dried up. The company’s figures suggest that it continued to fall by 23 per cent in the first quarter of the year and by 18 per cent in the second.
Natural resources was the weak spot again in the interim figures, with revenues at constant exchange rates off by another 12.3 per cent. This is only 6 per cent of the business, though, and the others, new products and trade, were well ahead, by 6.4 per cent and 7.5 per cent, respectively. The shares gained 394p to £46.95 on the back of results that showed organic growth up 1.7 per cent and margins up by 110 percentage points, the third consecutive trading statement to feature improvements in these areas.
In addition, the interim dividend is raised by 21 per cent, in line with earnings per share, and cashflow was up by more than £75 million on the first half of 2016. All this left pre-tax profits at the reported level 28 per cent higher at £190.8 million. The drivers for the two growing parts of the business, the number of new products coming to the market and world trade, particularly among less developed economies, continue to be strong.
Intertek, under André Lacroix, who arrived in May 2015, has been cutting back on the number of less profitable lines it operates. Traditionally it has grown by acquisition, but the pace has been slackening off of late. Of the 13.9 per cent rise in reported revenues, only 1 per cent came from earlier purchases and 11.2 per cent from the lower pound. The shares have risen from below £31 in November and, selling on 25 times this year’s earnings, look fully valued.
MY ADVICE Avoid
WHY Good prospects appear to be in price already
