Cronos Group Inc. (CRON) Q4 2020 Earnings Call Transcript
CRON earnings call for the period ending December 31, 2020.
The tobacco industry may be reviled by some, but it has been a darling of investors for much of its history. Throughout the 20th century, tobacco stocks were among the best performers, benefiting from an addictive, highly profitable, recession-proof product, plus a reputation for offering generous dividend yields to investors.
In fact, according to Wharton professor Jeremy Siegel, Altria Group (NYSE:MO), domestic maker of the Marlboro brand, was the best-performing stock on the market from 1968 to 2017 when including reinvested dividends. The cigarette maker's annualized average return was 20% during that time.
The tobacco industry produced some of the 20th century's best performing stocks.
Today, however, tobacco companies face a new set of challenges. Smoking rates have steadily declined around the world, and especially in the U.S., amid health concerns and increasing regulations. As a result, the industry has sought to pivot to next-generation products like e-cigarettes and vaporizers, which circumvent some of the drawbacks of smokable cigarettes like unwanted odor, and are perceived by some as better for your health. Some companies have looked beyond tobacco, partnering with cannabis businesses in order to capture the breakout growth in an industry that bears many similarities to tobacco.
Tobacco stocks come with a number of risks, however, including increased regulation of the underlying companies and declining smoking rates. Revenue and profit growth have been slow across the industry, but these stocks still hold appeal for investors because their profits and dividends have been so reliable. Investors are hopeful that next-generation products will eventually catalyze stronger growth.
A wave of consolidation in the industry has left just three major players in tobacco: Altria, Philip Morris International (NYSE:PM), and British American Tobacco (NYSE:BTI). With few competitors, these companies have been able to raise prices to generate more profits, even as cigarette sales volumes have fallen. After the big three, there are some smaller stocks that investors may want to consider, including those of Imperial Brands (OTC:IMBBY) and Vector Group (NYSE:VGR).
Most of the discussion around tobacco stocks focuses on traditional cigarettes and next-generation products, but it's worth noting that these tobacco companies also sell smokeless products like chewing tobacco, as well as cigars, pipe tobacco, and accessories like rolling papers.
The COVID-19 pandemic has had an impact on the industry, forcing plant shutdowns and slowdowns, and has even impacted duty-free sales for Philip Morris. Additionally, Altria's 9.5% stake in Anheuser-Busch InBev (NYSE: BUD) gives it additional exposure to the crisis, as the alcohol sales have contracted significantly due to the closures of bars and restaurants around the world. Still, as a part of the consumer staples sector, the tobacco industry won't endure any lasting scars from the pandemic, and tobacco stocks' prices have mostly recovered since their sharp declines at the beginning of the crisis.
|Company||Sells smoke and smoke-free nicotine products?||Notable subsidiary brands|
|Altria Group (NYSE:MO)||Yes||Marlboro|
|Philip Morris International (NYSE:PM)||Yes||Virginia Slims|
|British American Tobacco (NYSE:BTI)||Yes||Camel|
Source: Company websites
The domestic manufacturer of Marlboro, Parliament, and Virginia Slims split from Philip Morris International in 2008, but still owns Philip Morris USA, the subsidiary that oversees Altria Group's cigarette brands.
Almost all of Altria's sales come from the United States, where smoking rates have steadily declined over the last generation. According to the federal Centers for Disease Control and Prevention, the percentage of American adults who smoke tobacco fell from 21% in 2005 to 14% in 2018. Not surprisingly, Altria's cigarette sales volumes have slipped, too. In 2019, its cigarette sales volume declined by 7.3%, though that decline through the first three quarters of 2020 moderated to just 1.4%, as the stress, extra time at home, and relief payments during the pandemic encouraged smoking.
The long-term decline in tobacco smoking explains why Altria has taken steps to diversify away from traditional cigarettes, most notably taking a 35% stake in e-cigarette manufacturer Juul Labs and a 45% stake in Canadian cannabis grower Cronos Group (NASDAQ:CRON).
However, those investments haven't played out as investors hoped. In December of 2018, Altria plunked down $12.8 billion for partial ownership of Juul, but after regulators forced Juul to stop making most of its flavored cartridges and questioned its marketing tactics, the e-cigarette company's valuation fell significantly. Altria has taken three writedowns on its Juul investment, and as of September, 2020, the stake was valued at just $1.6 billion, barely 10% of the purchase price.
The same month that Altria took a stake in Juul, it acquired 45% of Cronos Group for $1.8 billion and made the company its exclusive partner for cannabis. However, as of December, 2020, the value of that stake was down by more than 25%.
Altria Group does, however, remain a dividend powerhouse. It's raised its dividend 54 times in the last 50 years, effectively making it a Dividend Aristocrat (status unofficial because of its spinoff history). Management has set a target payout ratio of 80% of earnings per share, knowing that its dividend is the main reason that shareholders own the stock. As of December, 2020, its dividend yield was an attractive 8%.
While Altria has looked outside of the company to diversify and cushion itself from the decline of cigarette sales, Philip Morris is pursuing an in-house strategy. The company -- which sells many of the same brands that Altria does, except outside of the U.S. -- has pinned its hopes on heat-not-burn (HNB) tobacco products. Its primary offerings in this category are the devices and cartridges sold under its IQOS (widely believed to be an acronym for “I Quit Original Smoking”) brand.
While the HNB process is similar to the process used by vaporizers and e-cigarettes, devices like the IQOS use tobacco rather than the liquid made for vaporizers. By staying focused on tobacco, Philip Morris is taking advantage of the same supply chain for IQOS that it does for traditional cigarettes, while also enjoying attractive profit margins for IQOS cartridge sales. The company claims that HNB devices are safer than regular cigarettes because they don’t burn the tobacco; however, the science is still being debated, and the FDA has not concluded that HNB devices are safer than cigarettes.
Considering what happened with Juul, the IQOS brand runs a similar risk of regulatory crackdown internationally and in the U.S., where Philip Morris has partnered with Altria to sell the product line.
Like Altria, Philip Morris saw a decline in its cigarette sales volume in 2019, by about 4.5%, but its sales volume of heated tobacco units (HTUs) rose 44.2% in that same year, indicating that devices like the IQOS have strong growth potential. Through the first three quarters of 2020, the company's cigarette sales volumes plunged by 10.7% while HTU sales rose by 27.9%. Philip Morris finished the third quarter with an estimated 16.4 million IQOS users. Sales of HTUs are still much smaller than sales of traditional cigarettes, meaning that the IQOS brand still has plenty of runway.
As a dividend stock, Philip Morris does not disappoint, either. The company since it split from Altria in 2008 has raised its dividend every year and, as of December, 2020, increased its dividend by 161%; the stock also offers a healthy dividend yield of 5.7% of the share price. Including its history as part of Altria, it would be another Dividend Aristocrat.
British American Tobacco (BAT) has become a titan of the industry as well, fueled by its $49 billion acquisition of Reynolds American in 2017. Today, the company owns a range of popular cigarette brands, including Camel, Newport, Dunhill, Natural American Spirit, and Lucky Strike, as well as next-gen products like Vuse for vaporizing and glo for heat-not-burn smoking.
Like other tobacco companies, BAT is focused on substantially transitioning to next-gen products. Last year, the company saw a 4.7% decline in its cigarette sales volume, while its sales volume of tobacco-heated products rose by 31.6%. Sales from new categories were nearly $2 billion, but the vast majority of its revenue still comes from cigarettes. The company by 2025 is targeting five billion pounds-sterling ($6.7 billion at current exchange rates) in income from next-gen products.
The advantage of investing in British American Tobacco over Altria and Philip Morris is that it provides exposure to the tobacco sector worldwide, rather than in just the U.S. or just internationally; the company also sells a wide range of products including cigarettes, vaporizers, chewing tobacco, and heated tobacco. Buying shares of BAT is the easiest way to gain portfolio exposure to the whole tobacco industry via just one stock.
British American also pays a generous dividend yield of 7%, and its high operating profit margin, which topped 30% in 2019, helps to ensure the dependability of the quarterly payout.
Tobacco companies all find themselves facing the same conundrum these days. Though selling traditional cigarettes is highly profitable, that business is in decline and expected to keep declining. Tobacco companies need to find new ways to grow and diversify their businesses.
Investors may want to consider investing in a basket of tobacco stocks to gain exposure to different growth strategies and cut down on risk. While income investors can still count on tobacco companies to deliver dividends, the path to growth in the industry is uncertain.
CRON earnings call for the period ending December 31, 2020.
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BUD earnings call for the period ending December 31, 2020.
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