Month: March 2023

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British American Tobacco Valuation

Currently, British American Tobacco (BTI) is one of my largest stock holdings, a stock that I have owned since 2021. BTI is the largest tobacco company by sales, selling traditional tobacco products but also innovating in smokeless nicotine products. Tobacco stocks have been out of favor the past couple of years, with lackluster share prices. This depressed share price, and BTIs 7.5% dividend yield begs the question as to whether the company is currently trading below intrinsic value. In this post I will do a rough valuation of British American Tobacco in order to see if the stock is a bargain.

The first place I am going to start with valuing BTI is approximating their normalized operating earnings. Over the past 5 years, British American Tobacco has produced around $12B in operating earnings. This is slightly less than the 2022 figure of $12.6B, so I will use the more conservative figure of $12B. 

BTI usually pays around a 25% tax rate. Applying this rate to the estimated operating earnings produces an after tax earnings of $9B.

Next, I capitalize the estimated after tax earnings to produce an enterprise value. Typically I estimate a cost of capital based on historical P/E ratios, and also factor in the size and quality of the business. In recent years, BTI has been trading at a fairly low multiple. Prior to the large acquisition they made in 2017, British American Tobacco was regularly trading over 25 times earnings. Currently the company has an $80B market cap, which makes it a large cap. The high margins and large amount of cash produced by the company suggests some quality. On the flip side, tobacco companies are in favor with investors, which could produce higher cost of capital. For this analysis, I will use a discount rate of 6.7%. Capitalizing the $9B in after-tax earnings using this rate produces an enterprise value of $134B.

In order to convert the enterprise value into an equity valuation, the long term debt is subtracted from the EV, and the cash balance is added back. BTI has about $46.5B in debt, and about $4.1B in cash. This produces an estimated fair value market capitalization of $91.6B. 

Dividing the fair value market cap by the 2,267M shares outstanding, we arrive at a fair value stock price around $40. The current market price is around $35, indicating that BTI may be slightly undervalued. One thing that is in British American Tobacco’s favor is that they have historically paid out most of their cash flow out as dividends. Currently the stock has quite a large dividend yield, over 7.5%. Perhaps if investors bid up the stock to produce a more normal dividend yield, the stock would be worth more than my $40 estimate.

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Capital Allocation Snapshot: Investors Title Company

In this Capital Allocation Snapshot I am looking at Investors Title Company, a small insurer with a market cap around $300M. Investors Title (ITIC) provides title insurance for real estate transactions. I am interested in this business because it is a niche insurer, and it seems to be a quality microcap stock. As with any company that I am interested in, I seek to understand their capital allocation. In this post I will look at Investors Title cash flow statement to get a high-level overview of how they allocate their capital.

Cash Flow Summary

The first thing I like to do is look at 5 years of cash flow data to get an idea of where Investors Title is spending their money. The first line item is cash from operations. This figure decreased a bit from 2018 to 2019, bottoming around $21M. Over the next two years, the operating cash flow dramatically increased, peaking at $52M in 2021. Subsequently, 2022 showed ITIC producing less cash flow, but still more than 2020. Since Investors Title is dependent on the housing market, it makes sense that cash flows peaked in 2021 when there was a boom in house sales, then the housing market cooled off in 2022 with interest rates ticking up.

 Next is ITICs cash from investing. Four of the last five years showed spending of cash on investments. Investors Title had the highest year of investment spending in 2022 with almost $29M going towards investments. 

ITIC has only had outflows of cash for financing items during the last five years. Cash from financing was the highest during 2020-21, peaking at $37.5M, then largely falling off last year. 

Finally, Investors Title has a wide range in the net change of cash. The reduction in the cash balances in 2018 and 2022 were pretty modest, with 2020 showing a fairly large decrease of $12M. Investors Title had a large gain in cash during 2021, a decent gain in 2019. Overall, ITICs cash balance has increased over the five year period.

Cash from Investing

Looking deeper into Investors Title cash from investing, we see that capital expenditure nearly tripled from 2018 to 2022. Compared to ITICs operating cash flow, the capex spend does not indicate that the company is capital intensive, which makes sense as an insurer. It would be interesting to investigate why ITIC has increased capital expenditures so much recently. 

The next line item is Investors Title change in investments. ITIC has a securities portfolio that includes short term investments, bonds, and equities. Each year portions of this portfolio get sold and new investments get bought. Modest net proceeds from selling securities occurred in 2019 and 2021. Investors Title deployed a sizable portion of their cash into investments during 2020 and 2022. Compared to the operating cash flow, 2020 saw 33% of cash going into investments while 2022 saw this figure increase to 50%. Further analysis should be done to see what kinds of gains or losses ITIC is generated from their securities portfolio.

In 2022, ITIC acquired a subsidiary for $5M, but I can’t find any details from press releases or their latest 10k. Since Investors Title is nearly a $300M company, the acquisition is very small. From the five year data, it is clear that ITIC is not much of an acquirer of businesses.

The figures in the other category is quite small so they do not impact ITICs cash from investing too much.

Cash from Financing

The last, and sometimes most important section, of the cash flow statement with regards to capital allocation is the cash from financing. Investors Title has barely spent any cash repurchasing stock, these figures probably offset stock based compensation. 

The meat of ITICs cash from financing is the dividends. The dividends paid vary from year to year, and I have observed that ITIC often pays special dividends at the end of the year. The largest dividend payout was $37.5M in 2021, followed by nearly $32M in 2020. Last year saw $9M being paid, far lower than any other year over the past five years. From 2018 to 2020, ITIC nearly paid out all operating cash flow as dividends. The boon year in 2021 saw the company return the peak amount of cash to shareholders, but it was “only” 72% of operating cash flow. The paltry dividend payout in 2022 can be compared to the large use of cash towards investments that year. 

One thing missing from Investors Title cash from financing is the use issuance or payment of debt. This means the company does not need debt to maintain or grow the business, which is a plus.

Conclusion

Investors Title capital allocation appears to be pretty straightforward. The two main areas where ITIC is allocating their capital  is the change of investments, and the dividend. The cash flows to and from the securities book may be due to bonds maturing, so it is possible that large purchases of securities is not really an active capital allocation decision. As for the dividend, ITIC typically pays out a large portion of operating cash flow as dividends. This large dividend payout indicates that Investors Title does not need to retain earnings to grow the business, therefore they can return the cash to shareholders. 

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