Investing in fags, vapes and hash

[TheMotorcycleBoy]

@dealtn

So presumably the amortisation of intangible assets, is one possible cause of their decline in retained earnings? But that said, erosion of intangibles assets (if their accounting is above board), suggest that they have less resources next year to generate sales. Since intangible assets often comprise brands, patents, in house projects, so if they truly are amortised then without replacement then part of IMB's ability make cash in the future is reduced.

Matt

[Dod101]

It would take a fairly disinterested investor not to know that the tobacco companies face a long decline
Dod

Well Dod that may be true as I claim no prescience, but there are clearly plenty of them on here over the past couple of years as I was shouted down by them as they increased their holdings.

Its very difficult to draw too many conclusions from abbreviated accounts of companies as large as these, there is a lot of smoke and mirrors, as it were

The IC article notes that in the first half of this year IMB saw its cigarette sales fall by 6.9% and BAT by 3.7%. It won't take long for those scale of falls to have a material impact on revenues.

I am not decrying what you say, but it of course depends on the time scale involved. Some may feel it will a decade or more for any effect to be felt and that will be long enough for some! I will not increase my holdings (at least I think not) but I am not currently selling either. I think it may have been the same IC article which suggested the possibility that some who have gone over to vaping might just go back to cigarettes if there is ne benefit by vaping. I have no idea about the respective costs because I have never smoked.

Dod

[TheMotorcycleBoy]

Well more potential bad news for nicotine users and investors alike this morning, R4 reporting NYU School of Medicine's latest research. Which suggests it's the nicotine which is a carcinogen (rather than merely the delivery mechanism whether that be tobacco smoke or synthetic volatile liquids). I'll quote and link references here, and let you all draw your own conclusions:

Exposure to electronic-cigarette (E-cig) smoke caused mice to develop lung cancer, a new study finds.

Published online October 7 in Proceedings of National Academy of Sciences (PNAS), the study found that 9 of 40 mice (22.5 percent) exposed to E-cig smoke with nicotine for 54 weeks developed lung adenocarcinomas. None of the 20 mice from the study exposed to the same E-cig smoke without nicotine developed cancer.

Led by Moon-shong Tang, PhD, of NYU School of Medicine, the study also found that 23 of 40 mice (57.5 percent) exposed to E-cig smoke developed bladder hyperplasia, genetic changes that make cells more likely to multiply, and a step toward abnormal tissue growth seen in cancer.

Only one of the 17 mice exposed to the zero-nicotine E-cig smoke developed hyperplasia.

Tang acknowledges the study's limitations, including that it was conducted in a relatively small number of mice susceptible to developing cancer over their lifetime (one-year study period designed to offset age-related cancer).

The study mice also did not inhale smoke like a human would, but, instead, were surrounded by it (whole-body exposure).

"Tobacco smoke is among the most dangerous environmental agents to which humans are routinely exposed, but the potential of E-cig smoke as a threat to human health is not yet fully understood," says Tang, a professor in the Departments of Environmental Medicine, Medicine, and Pathology. "Our study results in mice were not meant to be compared to human disease, but instead argue that E-cig smoke must be more thoroughly studied before it is deemed safe or marketed that way."

....

The question of whether nicotine itself, separate from tobacco smoke, causes cancer is controversial because of conflicting study results over time that used oft-criticized methods. Almost all researchers agree, however, that chemicals added during the curing of tobacco - nitrate and nitrite - can cause a reaction called nitrosation (the addition of a particle called a nitrosonium ion), the authors say.

This is known to convert nicotine into nitrosamines such as NNN (N-nitrosonoricotine) and NNK (nicotine-derived nitrosamine ketone), proven carcinogens in mice and humans.

Conventional thinking, says Tang, has been that smoke from cured tobacco deposits nitrosamines into a smoker's organs and blood, with nitrosamine blood tests the best measure of their potential to cause cancer.

Such tests in a 2017 study found that levels of a compound related to NNK, called NNAL, were 95 percent lower in E-cig smokers than in tobacco smokers, leading some experts to conclude that a switch to E-cigs might save millions of lives. Partly as a result of such public messaging, 3.6 million junior high and high school students having embraced E-cigs, say the authors.

Against this backdrop, the new study finds that mammalian cells contain their own nitrosonium ions, which directly react with nicotine to form nitrosamines, including NNK. Many studies have also shown that human and mouse cells also have ample supplies of cytochrome p450, which further converts NNN and NNK into compounds (e.g. formaldehyde and CH3N=NOH) that can react with DNA to form damaging adducts (e.g. gamma-OH-PdG and O6-methyl-dG), the researchers say.

Tang's team had shown in a February 2018 PNAS article that E-cig smoke induces DNA damage in the mouse lung and bladder, and that nitrosation in cultured human lung and bladder cells converts nicotine into derivatives that increase DNA code changes (mutations) with the potential to transform normal cells into cancer cells. Specifically, the earlier study found that nicotine is transformed into nitrosamines, then into DNA damaging agents, which ultimately form DNA adducts.

The current study results confirm that nicotine from E-cig smoke can cause cancer in the lungs, and precancerous growth in the bladders, of mice. Furthermore, the results argue that nicotine, once inside cells, is converted into nitrosamines that do not leave cells and, therefore, could never be captured by tests that measure nitrosamine levels outside of cells (e.g. blood tests), says Tang.

The rest of the article can be found here:
https://eurekalert.org/pub_releases/201 ... 100219.php

Matt

[jackdaww]

i have disposed of most of my imps and bats .

i see only a declining SP and possible dividend cuts.

[TheMotorcycleBoy]

Have just sold 31 more of our IMBs at 1833p, and raised my stop loss to sell the remainder (only 32 now) if the SP falls to 1700p.

As people here will probably realise I'm still interested in the cannabis-type investment opportunities but for various reasons I believe the chances of IMB realising these are quite slim. They don't seem to have the necessary commitment, I imagine they only bought Auxley and Oxford Cannabinoid as gesture to shareholders, and don't think they have the capital (or could get at low enough rates) to do the necessary full investment into MJ. And then they would morph to a totally different company, i.e. one with higher risk in a more competitive space.

Matt

[PrefInvestor]

Have just sold 31 more of our IMBs at 1833p, and raised my stop loss to sell the remainder (only 32 now) if the SP falls to 1700p.
Matt

Hi Matt, Good for you. The health impact of cigarettes have been known for a long time, but not accepted by many and ignored by many others. Not in the least surprised to hear that vaping also has similar problems, but in truth is that given that people have come to ignore the health effects of normal cigarettes most will likely ignore anything discovered about vaping as well. The smoking habit is an addiction after all and getting out of it isn’t easy – and many don’t even want to.

The REALLY surprising thing is that the manufacturers of all of these products haven’t been put out of business by the size of the legal settlements against them which look to be substantial (but clearly not substantial enough), see wikipedia article below:-

https://en.m.wikipedia.org/wiki/Tobacco ... _Agreement

It’s kind of the equivalent BPs Macundo incident for the cigarette industry, but not quite seen in the same light…..

ATB

Pref

[dealtn]

@dealtn

So presumably the amortisation of intangible assets, is one possible cause of their decline in retained earnings? But that said, erosion of intangibles assets (if their accounting is above board), suggest that they have less resources next year to generate sales. Since intangible assets often comprise brands, patents, in house projects, so if they truly are amortised then without replacement then part of IMB's ability make cash in the future is reduced.

Matt

Yes retained earnings will go down (broadly speaking) if dividends paid out exceed earnings for any given year. But dividends are paid out (broadly speaking) from cash, not earnings and so long as distributable reserves exceed the dividend paid nothing untoward is occurring.

The latest set of accounts available are somewhat dated now but I suspect the next set when they are published won't be too dissimilar. Unfortunately there isn't a note about intangible assets in the latest set (and I'm not tempted to go hunting in previous years), but in both 2017 and 2018 there were reductions in earnings due to amortising acquired intangible assets. There will no doubt also be non-acquired intangible assets, but these aren't being amortised. These acquired intangible assets were presumably "brands etc." bought by IMB when they made an acquisition. Essentially they made a purchase at "market value" of something with a (possible much) lower "book value". The difference is amortised over the life of the asset, using whatever accounting period is considered correct and prudent. But its a book entry only.

Imagine the (completely unrealistic) scenario where a new accounting standard came in tomorrow forcing acquiring companies to write down the value of acquired (and even internal non-acquired) intangible assets to zero immediately, even though they still have a "market value" (Ie. they could be sold for cash to a competitor say, at some price). The earnings would take a huge hit in that year. Without looking, for IMB it could well mean a "loss" for the year of £15-20bn. However that loss, on the back of the "write down" wouldn't affect that years cash flow, or debt, or cash in the bank etc.

Now I'm sure such a loss would generate headlines, but this is still accounting only, the company still owns the brands, still sells millions of packets of them each month, they haven't disappeared. Going forward with no more "amortisation of intangible assets" in each year's Profit and Loss statement you would "suddenly" be seeing a company with earnings a magnitude of £1bn or so higher, and (given that cash conversion of earnings is close to 100%, with no reason to assume it would be much different going forward) broadly similar to its annual cash flow.

You would be looking at a company with earnings of >£3bn a year, with debts of say £13bn, what value would you put on that? Lets make the, again completely unrealistic assumption, that it abandons the dividend and uses all (cash) earnings to pay off the debt over say 5 years, before reverting to paying out dividends again. Even assuming earnings collapse to just £2bn a year at that point, you have a highly cash generative company with no debt, which I am sure would be valued on a P/E of at least comparable to now of about 7, probably closer to 10. Were earnings around £3bn with a P/E of 10 the share price would be about double what it is today (or where it was 2-3 years ago).

[Alaric]

Well more potential bad news for nicotine users and investors alike this morning, R4 reporting NYU School of Medicine's latest research. Which suggests it's the nicotine which is a carcinogen (rather than merely the delivery mechanism whether that be tobacco smoke or synthetic volatile liquids).

Before the invention of vaping, another route off tobacco could be via nicotine infused gum, lozenges or patches. These will have been around at least twenty years, probably longer, without generating health scares in their own right.

[TheMotorcycleBoy]

Hi dealtn,

Thanks for getting back to me,

Yes retained earnings will go down (broadly speaking) if dividends paid out exceed earnings for any given year. But dividends are paid out (broadly speaking) from cash, not earnings and so long as distributable reserves exceed the dividend paid nothing untoward is occurring.

Ok I quickly checked out their IMB FY2018 page 87. It's debatable whether IMBs recent dividends were made out of cash. From a consideration of purely Net CFO and their main finance costs:

In £millions
Net cash from ops  3087
Dividends          -1676
Repayment of debt  -2261
Interest           -501

meaning they were under water by 1350. That's not particularly cash generative. Indeed also in the financing section of this AR:

Increase in borrowings 1,619

Which is an almost identical figure to that of their divs payout. This seems fishy. Note also Operating profit was (only) 2400 and they added back out to this more than half i.e. 1266 via impairment and D+A.

These acquired intangible assets were presumably "brands etc." bought by IMB when they made an acquisition. Essentially they made a purchase at "market value" of something with a (possible much) lower "book value". The difference is amortised over the life of the asset, using whatever accounting period is considered correct and prudent. But its a book entry only.

Apologies for my pedantry, but strictly speaking when there is a purchase at market value where this is over book value, I believe the difference will have a separate accounting entry, that of "Goodwill". I *believe* goodwill is not depreciated/amortised, but it is tested for "impairment".

https://ion.icaew.com/financialreportin ... ortisation

but this is still accounting only, the company still owns the brands, still sells millions of packets of them each month, they haven't disappeared.

But regardless of accounting terminology (amortisation or impairment) or the entry being adjusted (goodwill or intangible assets), then if IMBs financial officer is being above board, then impairing/amortising an asset especially if it is essentially abstract e.g. an intangible asset or accounting goodwill, can surely only mean one thing: it's ability to earn money has diminished.

You would be looking at a company with earnings of >£3bn a year, with debts of say £13bn, what value would you put on that? Lets make the, again completely unrealistic assumption, that it abandons the dividend and uses all (cash) earnings to pay off the debt over say 5 years, before reverting to paying out dividends again. Even assuming earnings collapse to just £2bn a year at that point, you have a highly cash generative company with no debt, which I am sure would be valued on a P/E of at least comparable to now of about 7, probably closer to 10. Were earnings around £3bn with a P/E of 10 the share price would be about double what it is today (or where it was 2-3 years ago).

What earnings do you mean for IMB FY2018 on page 83, I'm seeing Operating earnings at about £2.4B and Net earnings as £1.4B?

Matt

[TheMotorcycleBoy]

Well more potential bad news for nicotine users and investors alike this morning, R4 reporting NYU School of Medicine's latest research. Which suggests it's the nicotine which is a carcinogen (rather than merely the delivery mechanism whether that be tobacco smoke or synthetic volatile liquids).

Before the invention of vaping, another route off tobacco could be via nicotine infused gum, lozenges or patches. These will have been around at least twenty years, probably longer, without generating health scares in their own right.

I used nicotine gum once. Issues:

1. There's no rush, like that associated with smoking. So it never take off.
2. It doesn't look as glamorous as smoking. So it never take off.
3. Finally according to https://eurekalert.org/pub_releases/201 ... 100219.php it's nicotine not the delivery system which is carcinogen

Matt

[Alaric]

I used nicotine gum once.

Enough people used gum, lozenges and patches before vaping existed to give a plausible population size for long term health risks directly arising from nicotine to have been identified. But these products have only ever been available in pharmacies and on the "medicines" aisle of supermarkets.

[TheMotorcycleBoy]

I used nicotine gum once.

Enough people used gum, lozenges and patches before vaping existed to give a plausible population size for long term health risks directly arising from nicotine to have been identified. But these products have only ever been available in pharmacies and on the "medicines" aisle of supermarkets.

I don't understand your point.

Those oral delivery systems were *only* ever used by folk addicted to ciggies who dreamed that this method of introduction of N would help them cure their addiction (never worked). But clearly since all this population group *already* smoked, this was *never* a controlled environment to determine the effects of N, as separate from the delivery sys.

Matt

[Alaric]

I don't understand your point.

My point is that if Nicotine in its own right was a serious health risk, users of such products might have been expected to have developed symptoms aside from their previous use of tobacco.

Perhaps the issue is that vapers who never smoked are at risk, but I suspect the vaping risk is from the oil as much as the Nicotine as aren't there Nicotine free options?

[dealtn]

Matt,

thank you for the reply, and the link, which goes to a far more comprehensive set of company accounts than I was using, so that is very useful (although it will take me some time now to go through it!)

I haven't quoted the previous exchange, for the benefit of brevity of this reply. However I am having trouble understanding your concerns about dividends being paid from cash flow. Directly from the cash flow statement there is approx. £3bn of cash from operating activities, in other words the purchasing of raw materials, manufacturing into tobacco product (and paying wages, marketing etc.), and the reselling of the end product (and paying tax) produced a net cash inflow of £3bn.

The company then decides what to do with that "cash". Ignoring a host of small entries some of which net, the company is obliged to pay interest on its debt, nothing too controversial here surely, using approx. £0.5bn., and in addition pays dividends of £1.7bn. Let's call that £2.2bn of the £3bn accounted for, leaving £0.8bn more to be retained in the business as cash, or used to repay debt or repurchase shares (or something else). The company is more than covering its dividend, and interest, out of its operating cash flow.

Where there may be some confusion is with respect to "increase in borrowing" I suppose. The company had 3 debt maturities in the year. We have a note in the accounts (Note 18) that details these totalling just over £2bn, so with "only" £0.8bn cash left over (from above paragraph) the company isn't able to repay these fully as they fell due, and chose to roll over part of the debt. (It could have anticipated this, decided to cut the dividend, and used the cash to fully repay the debt maturing, but chose not too - debt repayments are "lumpy" and few companies would have done this imo). The company issued just over £1.5bn in ECP in the year to this end (again Note 18).

I don't see anything "fishy" here. If I had a £300k house against which I had a £200k mortgage maturing, which I remortgaged with a new (cheaper!) loan of £150k, utilising £50k of my annual earnings I had saved I would be pleased with the outcome, despite having taken on a new debt. Would you think otherwise?

Now having seen Note 18 I am in fact further comforted in that the new debt is all short dated, sub 1 year, and no increase in long term liabilities occurred. In fact they reduced but this is simply because the passage of time had reclassified some of the long term liabilities as now "current" ones.

Having now a more comprehensive set of accounts I see we now have a note (Note 11) to do with intangible assets. These breakdown into a fairly even split between Goodwill, and Intellectual property. The former isn't being amortised (so my previous assumption doesn't hold as an explanation). The latter is being amortised, so it is here I would need to be satisfied that whilst it isn't a cash cost, it doesn't need to be refinanced as a cash cost at some later date. I haven't had a chance to do this yet. I am however (initially) comforted by this asset class having 2 lines against it of accumulated amortisation, and accumulated impairment, with the more worrying latter category being very small.

[Dod101]

Just to add to dealtn's comments. I read somewhere in the IMB accounts that they are anticipating around £2 billion from the sale of their cigars business and maybe others within the next few months and that will help towards repaying that short term debt that dealtn comments on (I assume)

Thanks dealtn for these detailed comments.

Dod

[TheMotorcycleBoy]

Matt,

thank you for the reply, and the link, which goes to a far more comprehensive set of company accounts than I was using, so that is very useful (although it will take me some time now to go through it!)

No probs!

I haven't quoted the previous exchange, for the benefit of brevity of this reply. However I am having trouble understanding your concerns about dividends being paid from cash flow. Directly from the cash flow statement there is approx. £3bn of cash from operating activities, in other words the purchasing of raw materials, manufacturing into tobacco product (and paying wages, marketing etc.), and the reselling of the end product (and paying tax) produced a net cash inflow of £3bn.

Strictly speaking it was only(!) £2.4bn operating earnings (page 83). They added back £1.26bn from non-cash charges of Imp+Dep+Amort.

The company then decides what to do with that "cash". Ignoring a host of small entries some of which net, the company is obliged to pay interest on its debt, nothing too controversial here surely, using approx. £0.5bn., and in addition pays dividends of £1.7bn. Let's call that £2.2bn of the £3bn accounted for, leaving £0.8bn more to be retained in the business as cash, or used to repay debt or repurchase shares (or something else). The company is more than covering its dividend, and interest, out of its operating cash flow.

Well I do agree with your maths there they certainly will have £0.8bn left at that point i.e. after divs+interest charges. However at 20% CT the taxman will ask for £0.4bn at some stage, and to cover their capex for the last 2 years they've spent about £0.25-0.3bn. So to be honest, you are right they can just about afford divs. from cash, but obviously with our above calcs. none really is spare to pay down debt etc. or stock repurchase, whatever.

Where there may be some confusion is with respect to "increase in borrowing" I suppose. The company had 3 debt maturities in the year. We have a note in the accounts (Note 18) that details these totalling just over £2bn, so with "only" £0.8bn cash left over (from above paragraph) the company isn't able to repay these fully as they fell due, and chose to roll over part of the debt. (It could have anticipated this, decided to cut the dividend, and used the cash to fully repay the debt maturing, but chose not too - debt repayments are "lumpy" and few companies would have done this imo). The company issued just over £1.5bn in ECP in the year to this end (again Note 18).

I don't see anything "fishy" here. If I had a £300k house against which I had a £200k mortgage maturing, which I remortgaged with a new (cheaper!) loan of £150k, utilising £50k of my annual earnings I had saved I would be pleased with the outcome, despite having taken on a new debt. Would you think otherwise?

Well you are talking to a guy who scrimped and saved to clear his household's £80k mortgage back in, oh, about 2008! Never wanted to ever borrow again!

Ok I can see now, that the £1.6bn increase in borrowings could be construed as merely debt refinancing, since for 2018 they paid down £2.3bn of debt, but borrowed £1.6bn. Just a coincidence it's a very close figure to their dividend bill.

Now having seen Note 18 I am in fact further comforted in that the new debt is all short dated, sub 1 year, and no increase in long term liabilities occurred. In fact they reduced but this is simply because the passage of time had reclassified some of the long term liabilities as now "current" ones.

Indeed, that's some comfort.

Having now a more comprehensive set of accounts I see we now have a note (Note 11) to do with intangible assets. These breakdown into a fairly even split between Goodwill, and Intellectual property. The former isn't being amortised (so my previous assumption doesn't hold as an explanation). The latter is being amortised, so it is here I would need to be satisfied that whilst it isn't a cash cost, it doesn't need to be refinanced as a cash cost at some later date. I haven't had a chance to do this yet. I am however (initially) comforted by this asset class having 2 lines against it of accumulated amortisation, and accumulated impairment, with the more worrying latter category being very small.

Yes. I can only predict more amortised/impaired IP in the future as they accept that investment in new delivery systems (i.e. vape mechanisms and chemicals) will not return as they'd once planned?

Well given the above debate re. their finances, I would agree they are hanging on in there. However, the recent developments re. popularity of any nicotine delivery system (i.e. nicotine itself is almost certainly as carcinogen as just the smoke and the nitrates) lead me to conclude that this unfortunately is not the long term investment I'd hoped it would be. For me at least!

Many thanks,
Matt

[TheMotorcycleBoy]

I don't understand your point.

My point is that if Nicotine in its own right was a serious health risk, users of such products might have been expected to have developed symptoms aside from their previous use of tobacco.

Perhaps the issue is that vapers who never smoked are at risk, but I suspect the vaping risk is from the oil as much as the Nicotine as aren't there Nicotine free options?

Alaric,

aside from their previous use of tobacco.

but given that those folk we have used gum (or patches) and fags, you *must* realise that there would be no scientific way to be determine the causal delivery system. TBH the stuff in the NYU research which I outlined earlier is enough for me to be considered that a investing in human consumption of nicotine is flogging a dead horse.

Matt

[TheMotorcycleBoy]

More bad news for NGPs. SK consider a ban:

https://uk.reuters.com/article/uk-healt ... KKBN1X205C

[TheMotorcycleBoy]

Well my Stop loss of £17 on IMB was hit for my remaining shares.

Despite, them according to this buying back their own shares since July 10th.

Guess that's our short investment in fags and vapes finished.

Matt

[tjh290633]

As they report next Tuesday, see https://www.imperialbrandsplc.com/inves ... #category1 it might have been worth waiting until after then to set your stop-loss.

TJH