Summary:

 

 

The most important risk is that Zyn would lose significant market share as both BAT (Velo) and Altria (On!) were aggressively entering the nic pouch market at the end of 2020. After an initial sharp drop in market share, Zyn has stabilized and even increased its market share despite extremely aggressive pricing and strong shelf space acquisition from both competitors.

 

The second risk was the threat from the FDA to ban flavored cigars. There is good reason to suspect this will not happen. Namely, flavored cigars are used almost exclusively to smoke mj as blunts. This lessens the risk in two ways: (1) the filler tobacco is typically removed and (2) blunt users are not smoking the quantity of blunts as a typical cigar smoker would smoke of cigars. Further, the typical blunt smoker is a minority, and no one wants to be seen as targeting minority communities. I think this is slowing down the ban on menthol cigarettes, where there is a mountain of evidence of the harm. The FDA went thru a similar process with flavored smoking papers years ago. And to this day, the FDA has not enforced a ban on flavored smoking papers.

 

There is a third, less threatening risk, that would harm nic pouches. Namely, the FDA moving to ban all flavored nicotine products, including nic pouches. Unlike cheap cigars and vaping products, Zyn does not rely upon "sweet" flavors, but it does rely upon mint/coffee/cinnamon flavors, and this would hurt sales significantly. However, this would be a dramatic action taken by the FDA and is unlikely. Anecdotally, my town is isolated and a local law does ban all nicotine flavors so only Smooth Zyn is available. The owner of one of the few places to buy nicotine in town has told me he sells it as a crazy (and increasing) rate despite people preferring the flavors.

 

Unfortunately, this is a dreaded sum-of-parts story, but we have a catalyst as the company has announced its intention to spin off the cigar business this year. On a sum-of-parts basis, the nic pouches business now trades at an implied 22x forward NOPAT multiple. This has come down from 40x 15 months ago. As well, the company has been returning all cash flow to shareholders via share buybacks and dividends.

 

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Swedish Match has 3 products (SNUS and other oral tobacco; nic pouches; and cigars) in two geographies (U.S. and Scandinavia). The cigar business is exclusively U.S. For historical reasons (see name of company), they retain their matches/lighters business as well, but I will skip over that as it is only 3% of profits.

 

I will run all the numbers in SEK, but currently 2/3 of revenue and profits are from the U.S. so the USD equivalent stock price is the more relevant. As well, since the U.S. nic pouch business is the growth engine here, future profits will be increasingly weighted towards USD. In my valuation model, over 3/4 of the value is from USD.

 

The TEV is 120bn.

EBIT '21 was 8.0bn

I have nic pouches growing 25% and the other segments growing 10% y-o-y. Cigars will not sustain 10% growth, but 2021 had hiccups due to supply chain problems and so I expect a bounceback in 2022.

 

SWMA does not break out nic pouches vs SNUS et al, but we have enough data due to: (1) the rapid growth of nic pouches; (2) volumes of nic pouches; and (3) margin growth in Smokeless as nic pouches have grown to know two things: Nic Pouches are about 2/3 the revenue of SNUS et al, and they have better EBIT margins.

 

2022 Sum-of-Parts

SNUS et al - 8.6bn Revenue; 48% EBIT Margin; 4.1bn EBIT

Cigars/Lights - 6.5bn Revenue; 38% EBIT Margin; 2.5bn EBIT

Nic Pouches - 5.7bn Revenue; 52% EBIT Margin; 3.0bn EBIT

 

Putting a 15x unlevered FCF multiple on SNUS et al and a 12x on Cigars/Lights implies a 22x unlevered multiple on nic pouches.

 

So what is the nic pouches business worth?

 

I am an old value investor, and I almost never buy an operating business at over 20x. However, I believe the nic pouches market will continue to explode in the U.S. and Scandinavia. Further, I believe that Zyn has the dominant brand in the U.S. and will retain its market share among current users and continue to own a large share of new users. This is the key to the thesis. As well, there is a wildcard upside in countries without an oral tobacco tradition. Nic pouches have been slow to catch on outside the US/Scandinavia because there is no oral tobacco tradition. But this is all upside for SWMA and other nic pouch companies if the product breaks through.

 

Why am I so confident in market share retention?

 

First, it is just a better product. It is not powdery or papery like On! and Velo. Second, the brand has cachet and that is all-important in this category. Upper-middle-class people are not going to meet up with their friends at the bar with On! or Velo.

 

Second, BAT and Altria threw everything at Zyn in 2021 and Zyn withstood the onslaught. They each took a separate strategy. BAT booked almost no revenue from Velo in Q4. They literally gave it away to retailers and distributors to gain shelf space, which they did. They maintained minimum pricing and did not pass the savings onto consumers. 

 

Altria took a different strategy. They ran enormous promotions to consumers. 3 units for $2 (before taxes) versus $5 for 1 unit (before taxes) for Zyn.

 

Both Altria and BAT gained shelf space/store count equivalent to Zyn and Zyn's counter to the onslaught was a lit display case. Zyn held its ground. Velo and On! could improve their product but the brand mindshare fight has already been decided, and Zyn has won in the U.S. Interestingly, Zyn did not win in Scandinavia, and this was the core of the bear thesis 15 months ago.

 

In terms of demographics, Zyn skews younger versus the other brands. I have seen no data to confirm, but based on shelf space in different c-store locations, it also skews higher income. I can predict the shelf space (both visibility and size) to different brands in a c-store based on the demographics of the area with surprising consistency. Poorer areas skew heavily towards On! while wealthier areas skew heavily towards Zyn. The pricing differences also support this hypothesis. This is where a brand wants to be: younger and richer.

 

 

Risks (Listed above)

- The main risk is I am wrong about nic pouch TAM or Zyn market share

- Flavored cigar ban

- Flavored (including non-sweet flavors) ban on all nicotine products

 

Catalysts

- Cigar spin off

- Continued cash return to shareholders

- Continued growth in U.S. nic pouches

Catalysts

- Cigar spin off

- Continued cash return to shareholders

- Continued growth in U.S. nic pouches