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.
For Q3 2021, the portfolio is down 0.65%, and up 17.4% YTD. The Q1 starting balance was $144,722.98, and finished the quarter at $147,690.65. Contributions to the portfolio during the quarter amount to $3,948.
A few new positions were added this quarter in several of the portfolio categories. On the discretionary side, British American Tobacco (BTI) was purchased. The Deep Value category saw the addition of M/I Homes (MHO). Finally, SLV silver ETF was added to the precious metals holdings.
The current allocation of the portfolio is shown in the chart below. Currently, the portfolio consists of discretionary value stocks, oil tankers, deep value, 401k stocks, precious metals, and cash. It can be seen that 72.1% of the portfolio is in stocks, while 27.9% is in cash and safe haven assets.
During the quarter I received $231.90 total in dividends, which is broken down in the table below.
Ticker
Quarterly Dividend
FE
48.75
DHT
4.30
ITIC
5.52
EMR
42.93
COF
66.00
SPG
64.40
Total
231.90
Discretionary Summary
Discretionary value is the label I’m giving to the positions that are fairly large (~5% of the portfolio) I believe are undervalued and may have the following characteristics: quality business, competitive advantage, misunderstood by the market, or a good company in a heavily sold off industry. The current discretionary value stocks I own consist of Capital One Financial (COF), Emerson Electric (EMR), Simon Property Group (SPG), FirstEnergy (FE), British American Tobacco (BTI). The table below shows the cost basis, current value, and gains/losses for these positions.
The newest addition to the discretionary portfolio was the purchase of British American Tobacco. Cigarette volumes have been declining at a rate of 5% annually, and that trend is expected to continue. BTI is preparing for a “post-cigarette” world by developing alternative tobacco products that they claim is much more safe than combustables. While ESG funds are not allowed to own British American Tobacco, I don’t mind BTI’s 8% dividend yield.
Capital One recently announced they will enter the Buy-Now-Pay-Later (BNPL) space to compete with companies like Affirm. BNPL seems like a crowded space, so it will be interesting to see if COF can make an impact. With this announcement, it looks like I will be doing some homework on the competition..
First Energy announced their settlement with the DOJ concerning their bribery scandal. The company will pay $115 million to the US Treasury, and another $115 million to Ohio utility customers. These payments will be spread out over three years. With this scandal receding into the background, hopefully FE can revert to their pre-scandal price.
Avg Price
Cost Basis
Current Value
Current Gain (Loss)
COF
63.25
3,478.75
8,507.95
144.57%
EMR
41.00
3,485.00
8,180.40
134.73%
SPG
74.50
3,427.00
6,002.08
75.14%
FE
28.00
3,500.00
4,651.25
32.89%
BTI
37.45
7,114.91
6,703.20
(5.78%)
Tanker Stocks
Tankers have slightly improved this quarter, but are still a sore point in my portfolio. I wouldn’t be opposed to selling these stocks. However, I don’t have any better ideas, I already have a large cash position, and there is some hope they will work out in the medium term.
Avg Price
Cost Basis
Current Value
Current Gain (Loss)
DHT
8.17
1,755.90
1,395.35
-20.53%
FRO
10.66
1,738.29
1,467.00
-15.60%
STNG
26.63
1,742.67
1,499.40
-13.96%
TNK
23.86
1,765.88
1,067.08
-39.57%
Deep Value
Deep value is a sub-strategy I’m employing in my portfolio. This is a quantitative strategy that buys a basket of statistically cheap stocks. The metric I use is EV/EBIT, based on the wonderful book The Acquirers Multiple. Historically, this strategy has provided excellent returns, although it has not kept up with the S&P 500 the past few years. Additionally, I am making an effort to apply this strategy to microcap companies. Microcaps are classified as having a market capitalization between $50M-300M. These small companies are more volatile, but have the potential for attractive returns.
My position sizing is smaller than the discretionary side of my portfolio because I want to own a basket of about 20 stocks. Since this is a quantitative strategy, I do not spend much time analyzing these businesses. The main idea is that these companies are trading at very cheap valuations, and the winners will (hopefully) outnumber the losers.
Note: MSGN merged with MSGE during the quarter
Avg Price
Cost Basis
Current Value
Current Gain (Loss)
BIIB
275.00
2,475.00
3,116.43
25.91%
BTG
5.25
2,499.00
2,003.96
-19.81
HXL
36.80
1,803.20
3,057.60
69.56%
ITIC
164.54
1,974.48
2,095.56
6.13%
MSGE
16.00
2,000.00
1,822.50
-8.88
QDEL
120.00
2,520.00
2,690.52
6.77%
MHO
60.00
2,520.00
2,427.60
(3.67%)
RSKIA, FF, and BBSI were sold this quarter since I’ve held them for a year. RSKIA and BBSI realized attractive gains, while FF produced a loss. Last quarter Future Fuel paid out a special dividend, which I received about $300. With this special dividend, my return with FF was closer to breaking even. The new addition this quarter was the home builder M/I Homes (MHO).
Cost Basis
Sale Proceeds
Realized Gain (Loss)
RSKIA
1,740.75
2,690.23
54.54%
FF
1,794.00
1,310.99
(26.92%)
BBSI
1,767.50
2,572.48
45.54%
401k and Precious Metals
My 401k is through my current employer and actively receives contributions. The 401k consists of a Blackrock Target Date Fund (which is no longer being funded), and the Oakmark Fund. The Oakmark Fund is a large cap value fund. Since I am actively contributing to my 401k, it will naturally have a growing influence on my portfolio.
I also have a decent allocation to precious metals that are used as a bond substitute, recession and inflation hedge. This quarter, I added 100 units of iShares Silver Trust (SLV) at a cost basis of $20.52 a unit. The table below shows the YTD performance for the precious metals and 401k, which includes the effects of contributions.
12/31/20
9/30/21
YTD Gain (Loss)
YTD Contributions
Precious Metals
9,964.00
9,682.04
-6.84%
2,054
401k
32,252.43
54,845.18
21.91%
14,200.00
Books I’m Reading
This quarter I read “Kochland: The Secret History of Koch Industries and Corporate Power in America”. Prior to reading the book, I was not too familiar with the Koch brothers besides them controlling the largest private company in the country, them being libertarians, and that they are controversial. This book covers the history of Koch Industries, Charles Koch’s management philosophy, various Koch Industry scandals, and Charles Koch’s lobbying machine. Kochland has a somewhat negative bias against Charles Koch, which I kind of knew before reading, so the negative portrayal did not bother me.
Much of the book consisted of explaining how Koch Industries went into a new line of business, then some crises happened in that new business, then presenting 1st hand accounts from key people navigating said crisis. This process repeated several times. The book did provide a good overview of the history of the company. I wish it provided more financial data, but apparently Koch Industries is extremely secretive so that info is not usually released.
The chapters on Charles Koch’s political network were very interesting. I was not aware of how impactful Koch’s lobbying groups were at amplifying the Tea Party movement, blocking climate legislation, and meddling with Trump’s tax plan. Overall the book was quite the page turner, I just might seek out other books on Koch Industries to get an additional perspective.
