Description

A long term deep value opportunity

BAT Bangladesh overview (Ticker: BATBC)

BAT Bangladesh (“BATBC”), which is a 65.9% owned subsidiary of British American Tobacco and has a market cap of $431m, is the leading tobacco company in Bangladesh, with 50% market share, dominating the premium and medium price segments of the tobacco market (where it holds 75% market share). The brand portfolio of BAT Bangladesh includes Benson & Hedges, John Player Gold Leaf, Pall Mall, Capstan, Star, Scissors, Bristol, Pilot and Hollywood.

BATBC engages in the production and distribution of cigarettes (89% of sales) and in tobacco leaf export (11% of sales). Interestingly Bangladesh is among the 20 largest global producers of tobacco with c. $1.8bn of production in 2011. BATBC plays a key role in the economy since it is the largest private sector tax payer of the country, collecting ~$650m for the government in 2011 (including supplementary duty, value added tax and other taxes). This represents 2/3 of total tax collections from cigarettes industry in Bangladesh).

In 2011 BATBC achieved $329m of net sales and $36m of net income. The company has no debt and holds $10m of cash.

BATBC employs ~1,200 people directly and about 50,000 people indirectly as farmers, distributors and local suppliers. BATBC production capacity has recently been increased to 30bn sticks.

Tobacco Market in Bangladesh

According to the Global Adult Tobacco Survey: Bangladesh 2009, 23.0% of adult aged 15 years or above currently smoke tobacco in Bangladesh (for males 44.7% and for females 1.5%). The estimated number of current adult tobacco smokers is 21.9 million (21.2 million males and 0.7 million females). Among tobacco users 57% use cigarettes, 10% bidi and 33% non-smoke tobacco. As consumer spending capacity increases there is a gradual shift towards premium cigarettes.

Latest data on both consumption per capita and price per package indicate significant long term upside of the Bangladesh market (when compared to other more developed countries):

- Annual cigarettes consumption per capita in Bangladesh is approx. 200-300 sticks p.a. vs. ~800 in Malaysia; ~1,000 in Egypt; ~1,700 in South Korea and ~1,500-2,500 for developed countries.  

- Retail price per cigarette package is ~$0.5 vs. $1 in Egypt, $2 in South Korea, $3 in Malaysia and $5-7 in developed countries.

As a reference point Bangladesh GDP per capita (on a ppp basis) is $1,700 vs. Egypt’s $6,000, Malaysia’s $15,000 and South Korea’s $32,000.

As previously stated BATBC holds the leadership position in Bangladesh, followed by local player Akij, which recently started producing and marketing the world renowned Malboro brand. Although still a distant n. 2 Akij is likely to increase its market share over time thanks to its franchise agreement with Philip Morris. Dhaka Tobacco is the third player focused on low-price segment with 8 cigarettes brands and production capacity of ~12bn sticks p.a.

Total export market of Bangladesh tobacco is equal to $50m. Recently government has reduced taxes on tobacco exports from 10% to 5% to increase the competitiveness of domestic players on the foreign markets.

Brief history

The company’s routes go back to 1910 when it operated as Imperial Tobacco. After the partition of India in 1947, Pakistan Tobacco Company was established in 1949. The first factory in Bangladesh (the then East Pakistan) was setup in 1949 at Fauzdarhat in Chittagong. In 1965, the second factory of Pakistan Tobacco Company went into production in Mohakhali, Dhaka. Thereafter it became Bangladesh Tobacco Company Limited in 1972 immediately after Bangladesh independence. In 1998, the Company changed its name and identity to British American Tobacco Bangladesh.

Since 1977 British American tobacco has been listed on the Dhaka and Chittagong stock exchanges and today it is one the largest companies in terms of market cap.

Current shareholders base

In addition to BAT, which as previously mentioned controls 65.9% of the company, it is important to note that Bangladesh government owns 17.5% stake through Investment Corporation of Bangladesh. Other government-related entities (such as Shadharan Bima Corporation, Bangladesh Development Bank Limited, Government of People's Republic of Bangladesh, Sena Kallyan Sangstha) own 4.7% of the company, whereas the general public (including 2.7% stake of Vontobel Asset Mgmt) holds approx. 12% of the stock.

Management

- Golam Mainuddin, Chairman: appointed in August 2008, Mr Mainuddin has been appointed to the board of directors in 1986

- Arun Kaul, Managing director: appointed in July 2010, Mr Kaul, who joined BAT in 1996, has covered various leadership roles within BAT in a number of countries including General Manager of BAT Taiwan, Area Country Head of BAT Oman, Country Manager of BAT Philippines, General Manager of Egypt; Program Director of BAT Iran, Commercial Director of – Vietnam etc. Arun obtained Master’s Degree in Marketing Management from Kellogg Graduate School of Management, Northwestern University, U.S.A. in 1984.

- Anthony Yong, Finance Director: Mr. Yong joined British American Tobacco Asia Pacific Region in 2000 as Regional Finance Manager after having spent 8 years in KPMG performing audit and advisory services. Mr Yong has worked in BAT in Malaysia and Switzerland.

Historical financials

BATBC due to its competitive position and strong business model has historically enjoyed very good economics.

In the last 4 years the company achieved the following:
- Sales CAGR: 18% (2008-11 period), this was mainly driven by price hikes, following higher taxes. Demand volumes have been quite resilient
- EBIT margin: 18% (avg.). EBIT margin is currently 22% (vs. 34% of parent company BAT)

- ROE: >50% (avg.)

- ROIC (net of goodwill and cash): 112% (avg.)
- Unlevered FCF / Sales: 8% (avg.) – it is worth noting that in 2009 and 2010 production capacity has been expanded by 25% from 24bn sticks to 30bn sticks per year
Recent price increases: in 2011 the tobacco industry witnessed significant price hikes due to the plan in the 2011-12 government budget to increase supplementary duties from 10 to 30% (total duties and VAT are 69% of cigarettes retail price) and corporate taxes from 27.5% to 35%.

Intercompany fees: in 2011 BATBC paid $15m (5% of sales) to its parent company for “technical assistance fees and others”

Capital allocation

In the last 4 years ~100% of net income has been paid out as dividends. The number of shares have remained fixed at 60m since 2008 (no share-buybacks have been pursued, free float is already too limited to pursue value accretive sharebuybacks)

Investment rationale
1) Leading player in one of the most profitable (and most importantly predictable) segments of consumer staples: BATBC is the leading player (50% market share) in the tobacco business in Bangladesh. Tobacco is one of the best segments within consumer staples businesses since (i) brand loyalty is exceptionally high and (ii) demand tends to be quite inelastic to price changes. This leads to market share stability over time and exceptional returns on capital.

-  Interesting note: a study of the top performing stocks of the S&P 500 in the 1957- 2003 period ranked Philip Morris as n.1 in terms of returns (capital gains and dividends) with an impressive 19.75% IRR over 46 years! Furthermore out of the top 20 companies, 11 were in the consumer staples industry, which were well-known brands even in the 1950s.

2) At current price of 588 BDT per share ($431m market cap) BATBC offers a, attractive entry price at ~7x EV / EBIT, ~8% FCF / mkt cap yield and ~6-7% dividend yield (with no debt on the balance sheet).  

Considering the significant size of the Bangladesh population (167m) and the low starting base in terms of GDP per capita, BATBC current market price represents an interesting long term call option, considering the predictability of the tobacco business model and the fact that tobacco is already popular in Bangladesh (i) consumption per capita is 200-300 per capita and (ii) price per pack is $0.5 vs. $1-3 of more developed countries.

Assuming Bangladesh continues on its growth path (this is a big assumption considering the many challenges facing Bangladesh, but it is worth noting that Bangladesh economy has been growing at 6-7% in the last few years despite credit crisis), BATBC could potentially offer a 5-10x return over 10-15 years making the following company-specific assumptions:

(i) avg. retail price per package in Bangladesh increases to $1 ($1.3 for premium priced BAT cigarettes)

(ii) cigarettes consumption per capita reaches 600-1,000 cigarettes p.a. (and BAT maintains 50% market share)

(iii) stable EBIT margins >20%

(iv) exit multiple at 12x EV / EBIT

Interesting note: BAT Malaysia, which is listed and commands 65% market share in Malaysia, has a market cap of >$5bn. Please note that on one side the population of Malaysia is 29m (vs. 167m in Bangladesh), on the other its GDP per capita (on a ppp basis) is $15,000 (far above Bangladesh, even on a 10-20 years horizon…).

3) Interesting currency / economic exposure: on a ppp basis the Bangladesh Taka appears to be undervalued, but it is important to take into account that Bangladesh inflation is currently running at 10% and the Bangladesh Taka has depreciated ~20% vs. USD over the last 5 years and ~44% in the last 10 years. The main rationale for this investment remains the potential long term upside of Bangladesh spending capacity combined with the pricing power and market share stability of BATBC’s business model.

4) Corporate governance: majority ownership of BAT and minority ownership by Bangladesh government provides some protection for minority shareholders (it is unlikely that BAT will proceed to a take private of the company or charge excessive intercompany fees).

Key issues / mitigants

Relatively illiquid stock (even for a $5-10m investment) / this investment is of course suited for a relatively small fund that is willing to be patient for value to unlock over time, while being paid a good dividend yield (~6-7% at current valuations).

Bangladesh economy may not grow as expected / current BATBC valuation (and attractive dividend yield) offers some downside protection

---

A few notes on Bangladesh economy

Population: 167m (growing at ~1% p.a.)

GDP per capita (on a purchasing power parity basis) is ~$1,700

The size of the Bangladesh economy is $105bn ($270bn on a ppp basis). Despite various macro issues (e.g. lack of basic infrastructure, a number of natural calamities and often ineffective government policies), in the last few years Bangladesh economy has been growing at 6-7% p.a. (even in 2008-09 crisis).

Approx. 50% of the population is employed in agriculture (which accounts for 20% of the economy). In fact Bangladesh's soils, fed by the Ganges, Jamuna, and Meghna rivers, are considered highly fertile. Other important sectors include the textile industry (which employees 3.5m people). In 2009 Bangladesh overtook India in apparel exports, and it is n. 2 behind China. Bangladesh’s competitive advantage in textile industry is its low cost of labour, one of the lowest globally, which compares favorably vs. countries like China and Vietnam. . Minimum entry level wage is <$50 per month.  The low level of wages is attracting investments from abroad also in other industries. Although foreign direct investments have been below $1bn in the last few years, this number could increase significantly going forward. In September 2011 a few leading Indian companies (including Tata Steel, Bharat Heavy Electricals, Airtel and RPG Group) have expressed interest to invest in Bangladesh in gas drilling, tyre manufacturing, gas pipeline, power grid project, railway and telecommunication.

In 2011 inflation rate was equal to 10.5% (cigarette pack prices increased by 20-22%, showing pricing power of cigarettes producers).

Public debt is estimated to be <40% of GDP.

Catalyst