Cube Midcap Report (3 Jan 2020) – Clarity on flavours #BATS #NXT

Cube Midcap Report (3 Jan 2020) – Clarity on flavours #BATS #NXT

Good afternoon!

Today we have updates from two FTSE-100 constituents which I own in my personal portfolio:

Please note that I have long positions in BATS and NXT.

British American Tobacco (BATS)

  • Share price: £33.30p (+2%)
  • Market cap: £76.4 billion

Response to FDA flavour guidance

This is a large-cap investment which did not work out well for me, so far. I should eat humble pie in relation to BAT, before I brag about my success with NXT (to follow after this).

I’ve been in this one since October 2017:

So, what went wrong at BATS? The main problem has been the regulatory overhang. (By the way, I’m not claiming that regulations are bad for societal health – I’m purely talking investments!)

Again, we have plenty of material in the archives to peruse. I’ve covered it on numerous occasions, most recently in November. At that time, BATS reported that it was happy with progress in the United States – revenue in line with guidance.

The company reported 17.5% market share of the vaping market in the US – quite impressive for a name that is associated with old-school, traditional smoking. Its brand in this market is “Vuse“.

Unfortunately, the Vuse website is blocked outside the US. One way of accessing it is via the Wayback Machine (please don’t press this link if you are under 21!).

Today’s news

Today’s RNS is the BATS response to this document published by the Food and Drug Administration. It sets out what the FDA intends to do in relation to “Electronic Nicotine Delivery Systems” (ENDS).

The intentions and priorities of the FDA are:

  • to take action against flavoured, cartridge-based ENDS, other than tobacco and menthol flavours.
  • to take action against ENDS where access by minors has not been adequately prevented.
  • to take action against ENDS whose marketing is likely to promote use by minors.
  • from May, to take action against ENDS where the manufacturer did not make a premarket application.

The specific action that it will take on these products is “to prioritize enforcement of the premarket review requirements”.

Note that this is not equivalent to banning them. Instead, it will work to enforce the existing rules.

Flavours will get to stay, except those which are likely to appeal to children. According to CBS, the FDA says that flavours such as mint, fruit and dessert will have to go. But crucially, menthol will get to stay.

Let’s take a look at what BATS had to say. The headline is soothing:


And the comments are soothing, too. BATS is looking forward to “a properly regulated vapour category”, and agrees with the importance of preventing access by youth. I’ve addded the bolding:

  • “BAT’s U.S. subsidiary, Reynolds American Inc. (RAI), stands ready to comply with the new flavour guidelines”
  • “RAI has already submitted its first brand PMTA application and is well positioned to make further applications for the rest of its vapour portfolio ahead of the May 2020 deadline.”

  • “RAI is confident that, as required by the PMTA process, all VUSE products will be shown to be appropriate for the protection of public health.”

If this is true, it means that Vuse will emerge unscathed by this regulatory crackdown. What a result for BATS!

CEO Jack Bowles reiterates the view that marketing these products per se is not the problem, but rather it is the irresponsible marketing of them that is the problem.

My view

There is a lot to unpack here, and I would like to spend some more time, later today, reading the FDA document.

Overall, however, this seems like a very good result for BATS.

It has a strong US vaping brand in the form of Vuse. This brand should continue to grow in line with the segment as a whole, for the foreseeable.

While President Trump’s view on the subject of smoking is nuanced, allowing for the continuation of some forms of nicotine while banning others, his successor is very difficult to predict. It is possible, perhaps even likely, that future Presidents may take a harder stance.

So there is no way that BATS investors can relax. Growth opportunities might be hobbled. Existing products might find that their markets are restricted further. We shall see.

Along with the rest of the market, I’ve been waiting for progress on the company’s attempts to deleverage. If (hopefully when) that comes through, it will help to take some of the risk out of the stock, which could possibly lead to a higher rating. As ever, time will tell!

Despite buying BATS at nearly £45/share, my overall losses are shrinking with the help of its famous dividend stream. My breakeven price is now sub-£41. When you look at it this way (which I know is not the technically correct way to look at it!), my loss at the current share price is only c. 20%.

This stock used to trade at a mid-teen P/E multiple, but it was dragged down to single-digits by regulatory threats and the secular decline in traditional smoking. It is now c. 10x.

The contrarian in me believes that change might be slower than people think, and the power of the BATS brand portfolio might persist for longer than people expect. For as long as regulators allow people to smoke, there will be demand for legal ways to do it.


Next (NXT)

  • Share price: £68.98p (-1%)
  • Market cap: £9.2 billion

Trading Statement

This is one that I got right (so far).

It was really my colleague Paul Scott’s discovery, so I thank him for that. I’ve ended up owning it for longer than he has!

How time flies. In March, I’ll have owned it for three full years.

And it remains encouraging. Main points from today’s Q4 update:

  • full-price sales up 5.2% for the first two months of the quarter, including the Christmas period. This is ahead of expectations (note that the quarter ends in late January).
  • full-price sales up 3.9% for the year
  • profit guidance for the year nudges up to £727 million (pre-IFRS 16)
  • FY Jan 2021 guidance: full-price sales +3%, profit +1%, EPS +3.5%

This is another share that comes under my “buyback” theme. See my comments on Rightmove (RMV) in yesterday’s report.

The Next share count was 374 million in the year 2000. It is now just 133 million, i.e. it is down by nearly two thirds!

As I’ve said before, successful businesses with bright futures, generating more cash than they need, should buy back their own shares (so long as they don’t pay too much – the difficult bit).

From the figures above, you’ll see that profit growth of 1% translates to EPS growth of 3.5%. This is real EPS growth, even if some might argue that it has been financially engineered.

A growing online retailer that’s cheap!

Growing online retailers tend to trade at very large earnings multiples. Think Asos, Boohoo.

Next is a hybrid of traditional retailing, online retailing and credit card lending.

The traditional retailing part is the bit that makes investors nervous these days. Online retailing is considered glamorous, but in my mind it’s really just another way of delivering a catalogue – something that Next was always very good at. And lending to customers is the last bit of the jigsaw puzzle – a highly lucrative activity.

Here’s how the various segments of Next are growing:

I would focus on the right-most column, as it gives us the picture for the full year to date.

As usual, the traditional retail activity is struggling but it is more than offset by nice growth in online sales. So the total “product full price sales” line is growing (3.6%).

Finance interest income is growing faster again, boosting the final growth figure to 3.9%.

I could reprint here the table showing the revisions to profit guidance for FY Jan 2020, but it suffices to say that all numbers are improved slightly.

FY Jan 2021 – Guidance for group profit in the coming financial year is £734 million (on a comparable basis). Actual profits may be higher, due to a 53-week financial year.

Cash – surplus cash that’s available for shareholders would have grown by £12 million in the next financial year, according to forecasts. But HMRC has accelerated its demands for corporation tax payments. So there will be slightly less cash available for dividends and buybacks.

Buybacks – Next is wonderfully clear and logical in its approach to this subject:

…our intention is to return surplus cash to shareholders through share buybacks or special dividends.  Our buyback share price limit will continue to be based on achieving a minimum 8% Equivalent Rate of Return (ERR) on shares purchased.  As a reminder, ERR is calculated by dividing the anticipated pre-tax profits by the current market capitalisation of the Group.  Based on our profit guidance for the year to January 2021 of £734m and our current number of shares in issue, our price limit for share buybacks would be £71.76

Shareholders can therefore rest easy in the knowledge that either the share price will exceed £71.76, or the company will help to mop up some of the liquidity, getting decent value for its repurchases. If the share price exceeds £71.76, we will get a special dividend instead of the entire buyback (£145 million).

My view – absolutely no change to my view on this share. I remain greatly encouraged by its clear reporting, steady performance and logical approach to capital allocation. It might be fairly priced for now, but I expect that a continuation of the current strategy will lead to an acceptable outcome for shareholders (including me). Nothing is certain in this world – so fingers crossed!



That’s all for the Midcap Reports this week. Thanks for dropping by and see you again soon!





Wordpress (5)
  • comment-avatar

    Many thanks once again Graham. I don’t hold BATS but do hold IMB so this news is comforting for me too. Continue to hold in my ISA for the ridiculous yield.

    I do hold quite a few NEXT so all still looking good there – and a positive (possibly) read across to a couple of my other holdings in BooHoo and Sosandar – the next couple of weeks will tell.

    I guess you have to say it (please don’t press this link if you are under 21!) but wonder how many such readers you think you have?? 🙂

    • comment-avatar

      Thanks again for the feedback Laughton.

      Judging by the last Mello conference, there may by one or two minors following investment news. I would hate to be accused of encouraging them to start vaping!!

  • comment-avatar

    I don’t own Next but for fun did a very quick comp with AB Foods ABF, Asos ASC, and BooHoo BOO (which I sold two years too early). I expected ABF to ‘beat’ NXT but the latter actually ‘wins’ hands own on most measures including stuff like p/e and RoCE. ABF is (of course) very diversified and has low returns in sugar and agriculture but the Primark business looks very sound. On a standalone basis the ABF retail arm is at a similar level to NXT in sales and profits. My only concern with Next is the high debt level and fall in book value. But clearly NXT has been a super share to own in a difficult sector, miles better than ABF over the past few years.

    • comment-avatar

      Yes, Primark is v. impressive.

      Regarding Next debt level, are you taking into account that it is balanced by customer receivables? I wouldn’t want them to fund the entire finance arm by equity!

  • comment-avatar

    I had a quick look and you are quite right. The increase in debt which I referred to is largely the new item of capital lease obligations. I must confess I have tried to avoid reading learned dissertations on this subject, including your own I recall (?), as I try to largely stay awake during daylight hours.

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