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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Companies in long-term run-off sectors such as oil or tobacco face a stark strategic choice. They either extract as much value as possible from legacy assets and liquidate their stock, or they seek to build new sustainable businesses. Trying to do both carries execution risk. British American Tobacco risks falling between the two stools.
Its traditional business — which accounts for more than 85 per cent of sales and all of the profits — is struggling. BAT prefers to refer to it as combustibles, not cigarettes. On Wednesday, it reminded the market why. A £25bn impairment on its Reynolds American unit, coupled with lower growth estimates, incinerated nearly a tenth of the company’s value.
Consumers, it seems, are stubbing out their habit in droves. That is especially true in the US, where the cost of living squeeze and the growth of disposable vapes drove cigarette volumes down 11 per cent in 2022. BAT, which sells premium brands such as Camel, has suffered. Its group sales guidance for this year will only meet the bottom of a 3-5 per cent growth range.
Ordinarily, cigarette groups can easily offset volume declines by hiking prices, providing mid-single digit operating profit growth. But when volumes fall off a cliff, that is much harder. BAT has now signalled below-trend growth up to 2026, a factor in the share price reaction.
BAT has reiterated its commitment to a smokeless world. In the rather foggier world of accounting, that means the group no longer values its US brands into perpetuity. By shortening their economic life to 30 years BAT has lopped £25bn off the £67bn attributed to its US brands when it acquired Reynolds American in 2017.
That deal, in which BAT spent $49.4bn to acquire the 57.8 per cent it did not already own, valued the whole business at $100bn including debt. The write down, which does not affect cash flow, is still the equivalent of half of BAT market value today.
BAT is also doubling down on next generation products. Taken together, vapes, heated tobacco products and “modern oral” (nicotine pouches) should break even this year, earlier than expected. Yet this subscale business has marketing spend which eats into profit margins. It does not help that regulators view smokeless products with some degree of suspicion.
BAT will hope that it can grow its way out of this hole, with smokeless products taking off before cigarettes bow out. Judging from its poor shareholder return this year — even including a 10 per cent yield — only a decline in global interest rates will bring investors back to BAT.
Thames Water: for honesty, disclosure is the best policy
British American Tobacco is a run-off business to the extent that it continues to shrink. Thames Water deals with a very different sort of run-off. It now wants to shed a reputation as ripe as the sewage it spilled into two rivers in southern England.
Interim co-chief executive Cathryn Ross promised on Tuesday that Thames Water will be “honest” about what it delivers. The group will not fix its creaking infrastructure overnight. But Thames Water should commit to a clean-up it can pursue more rapidly: simplifying its murky financial structure.
It is inappropriate for a company with public service obligations and a local monopoly awarded by the state to have a structure that is so complex it is difficult to scrutinise. Complexity gives water companies room to quibble over what constitutes a dividend. That allows them to say no dividends have been paid when shareholders have extracted cash by other means.
Equally, MPs have accused Thames Water of using its complex structure to mislead them over a £500mn equity injection. Results for Thames Water’s parent, Kemble Water, revealed the £500mn injection was a loan from shareholders. It was “cascaded” to Thames Water via intermediate holding companies.
Thames Water has denied it misled MPs. True, the loan could at some point be converted to equity. The regulated company is under no obligation to repay it.
Thames Water meanwhile pays dividends that service debts of parent companies. In October, it gave £37.5mn to its immediate parent, Thames Water Utilities Holdings Limited. This was eventually paid to Kemble Water Finance Limited to service its external debt obligations and those of another subsidiary.
The borrowings of the group are not presented in Thames Water’s operating results. These show net debt at the regulated company increased 7 per cent year on year to £14.7bn. Net financing expenses decreased 20 per cent to £208.7mn.
Thames Water has said its shareholders have agreed to inject a further £750mn into the company. It is unclear how that injection will be structured.
Most big quoted businesses have a master holding company whose results give a clear picture of finances. Public utilities should mirror that structure, even if they are private.
Disclosure proves our honesty. If Ross wants the company to convince the public of its honesty beyond her own tenure, radical simplification is essential.
