12th November 2018

British American Tobacco, the FTSE listed Tobacco company’s bonds and stocks have traded down today (12 Nov-18) due to a press article discussing a potential FDA ban on menthol cigarettes.  Menthols last year represented 55% of BAT’s U.S. cigarette sales by volume (Source: WSJ), which makes any potential new regulation in this area a material risk for BAT. However, this is nothing new, the direction of travel for many years in developed economies has been increased regulatory intervention and increasingly punitive taxes on Cigarette consumption. Our base case has been that these moves will very likely continue.

In this context, we questioned the investment case of buying into BAT’s low coupon, long dated issuance as a “defensive” fixed income investment, even before we consider the likely trend towards ESG investing which largely prohibits investment in the sector.

This is not the only major headwind that BAT’s bond investors have had to face:

  • Rising leverage after the $25bn acquisition of Reynolds American
  • Increased litigation risk, resulting from cases which Reynolds had outstanding
  • Increasing E-Cigarette sales from competitors

Unfavourable business trends and regulatory developments could lead to further credit ratings drift, which could have implications for its high-grade holder base.

BAT issued €600m Euro bonds in March 2015 (BATS 2% 2045) and £650m of GBP bonds in September 2016 (BATS 2.25% 2052).  We have closely followed these bonds as we view them as “poster-childs” of the excesses of the QE-Era, when issuers were able to lock in ultra-low coupons on long dated debt.

At the time of writing, the aforementioned bonds are indicated as set out below:-

Security Mid Px Original issue px Change
£ BATSLN 2.25 52 70.5 98.9 (28.4)
€ BATSLN 2 45 77.0 97.8 (20.8)

Source: BBG, as at 11:45am BST on 12 Nov, indications only.

As illustrated above, investors who bought into this bond in the primary are now sitting on significant capital losses, that are unlikely to be compensated by the low coupons attached to both issues.


For more information please contact Rubrics Asset Management. info@rubricsam.com.


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