British-American tobacco (NYSE:BTI) owns the cigarette brands Camel, Newport, Lucky Strike and Pall Mall. Although it is a US cigarette manufacturer, it has a global presence that sets it apart from both Altria (NYSE:MO)which only operates in the USA, and Philip Morris International (NYSE:PM)which sells cigarettes internationally, but not in the US market.
British American Tobacco made a big admission about the future of the U.S. cigarette market in 2023 that investors in tobacco stocks shouldn’t ignore. Here’s what you need to know:
British American Tobacco has changed its accounting
Although a somewhat complex topic, it boils down to the accounting treatment of British American Tobacco’s US cigarette brands. The company previously assumed that the brands would be around forever – but now it has decided that at some point they will no longer exist. The company described the change as follows:
…effective January 1, 2024, Newport, Camel, Natural American Spirit and Pall Mall will be amortized using the straight-line method. Pall Mall is amortized over 20 years and Newport, Camel and Natural American Spirit are amortized over 30 years. From 2024, the increase in annual depreciation expense is expected to be £1.4 billion per year over the next 20 years, and is expected to decline to £1.3 billion thereafter.
In plain language, British American Tobacco is essentially saying that it expects Pall Mall as a brand to have little to no value in the US in 20 years. Newport, Camel and Natural American Spirit will likely end up in the same place just 10 years later. This is a big change and means the company will have to write down the value of the four brands every year, essentially creating a charge that takes into account the loss in value that year. These additional costs will negatively impact returns each year. This will have a significant lasting impact on the Company’s financial results.
But that’s not all. British American Tobacco’s decision also forced the company to immediately reduce the book value of the brands on its balance sheet:
In addition, the Group recognized a non-cash adjusted impairment charge of £23.0 billion on certain of our acquired US brands previously reported as perpetual, as well as an impairment charge on Reynolds goodwill of £4.3 billion. ..
The end of US tobacco is near
The bigger picture here is that British American Tobacco is effectively telling investors that the US cigarette market is not only in a steady decline, but that it will eventually go to zero. This had a significant impact on the company’s 2023 results, which fell deep into negative territory due to the write-down. To put it in numbers: In 2023, profits fell 322% compared to the previous year. However, it’s important to note that the headwinds will be smaller each year over the next 30 years as depreciation costs have increased.
And then investors need to consider the broader statement being made. British American Tobacco has a global portfolio of cigarette brands, with some markets performing differently than others. So there is a kind of balance to the US business.
But what about Altria? Altria and Philip Morris International effectively share Philip Morris’ portfolio of brands, most notably Marlboro. Philip Morris International sells the brands internationally, while Altria only sells them in the US market.
British American Tobacco’s accounting change essentially suggests that Altria’s cigarette business has an expiration date. Philip Morris International is in a better position because, like British American Tobacco, it operates in foreign markets.
The overall picture is not good for tobacco manufacturers
The U.S. is probably ahead to some degree when it comes to where cigarette demand is headed, so investors will need to pay close attention to the decision that British American Tobacco just made. The exact dates may not be known, but it shows investors that they should expect cigarettes to be phased out at some point.
And that increases the need for British American Tobacco, Altria and Philip Morris International to find new businesses to replace the dying cigarette lines that now dominate their profit and loss statements. If you are the owner of one of these companies, you need to pay very close attention to the success they achieve in finding a replacement for cigarettes. Given its U.S. focus, managing this decline is probably most important for Altria.
Should you invest $1,000 in British American Tobacco now?
Before you buy British American Tobacco shares, consider the following:
The Motley Fool Stock Advisor The analyst team has just identified what they think this is The 10 best stocks so investors can buy it now… and British American Tobacco wasn’t one of them. The ten stocks that made the cut could deliver huge returns in the years to come.
Think about when Nvidia created this list on April 15, 2005… if you have $1,000 invested at the time of our recommendation, You would have $544,015!*
Stock Advisor provides investors with an easy-to-understand roadmap to success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor has service more than quadrupled the return of the S&P 500 since 2002*.
See the 10 stocks »
*Stock Advisor returns as of April 30, 2024
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco Plc and Philip Morris International and recommends the following options: long January 2026 $40 calls on British American Tobacco and short January 2026 $40 puts on British American Tobacco. The Motley Fool has a disclosure policy.
“Why British American Tobacco’s Big Change Matters for High-Yield Investors” was originally published by The Motley Fool