Big profits from one of the most popular vices known to man
The year was 1981. My father’s company, Maersk Drilling, a subsidiary of Danish conglomerate AP Moeller, had just posted him to Singapore. As part of his expat package, he got a company car. I remember it well. It was a silver-grey Mitsubishi Sigma saloon. The seats were covered in crisp white cloth. But above all, I remember the driver. His name was Ali.
Ali had health problems. He was diabetic and he had emphysema. In spite of this, Ali smoked like a chimney. He was Indonesian, and what he smoked was kretek, or clove cigarettes.
If you’ve never been to Indonesia, or smelt clove cigarette smoke, it’s hard to describe. But it’s very distinctive and it lingers inside any building that still allows smoking. Imagine an all-pervasive wafting smell of sweet spicy smoke.
Smoking rates in Indonesia are among the highest in the world. More than three quarters of adult men smoke. I can corroborate the statistics. Here in Bali, my driver smokes. My gardener smokes. My pool cleaner smokes. Only my window cleaner doesn’t smoke.
By comparison, about 30% of French men smoke, half of Korean men, and 59% of Russian men. For women it’s another story, less than 4% of Indonesian women smoke, whereas in France it’s 25%.
Some years ago, an infamous story emerged of a 2-year-old Indonesian boy who was addicted to kretek cigarettes. How his parents ever let that happen is a mystery to me. I’m the father of two young girls. I can’t imagine I’d ever let them smoke. Happily, it would appear that this particular child has quit smoking and is now living a healthy lifestyle.
Ali, our driver in Singapore, should have quit too. But the uncomfortable truth is that most people just won’t quit. And the reality is, all over the world, the cigarette industry is a marriage of convenience between governments and big tobacco companies. It has been for over a hundred years.
Tobacco excise taxes are the largest single source of tax revenue
for the Indonesian government
They contributed 8.2% of the entire government budget in 2018. The government has hiked tobacco excise taxes twice since then, and the target is for them to contribute 9% of the entire budget in 2020.
It will probably be more. Unlike declining corporate taxes and income taxes due to the economic slowdown and job losses, the coronavirus probably won’t dent tobacco excise taxes as much.
So, while smoking harms many, the taxes those people pay on their cigarette purchases can also be used to help others.
Is it right or wrong to allow smoking? Is it right or wrong to invest in tobacco stocks?
I don’t intend to get into a moral argument. The undeniable fact is the tobacco industry exists and has done for hundreds of years. Moreover, it will continue to exist whether you or I invest in cigarette stocks or not.
The same argument can be made for so-called “sin stocks” in many other industries: junk food, soft-drinks, casino gambling, and weapons manufacturers, which I note are euphemistically called “defence stocks”.
I’m going to remain open to investing in everything. My behaviour as an individual won’t change the world. For those idealists who believe we can collectively change our behaviour to change the world, I would like to believe that too, but experience unfortunately has taught me otherwise.
I turn 47 this Sunday. I am no longer young and idealistic.
I’m a big believer in just keeping my head down and accepting what is, rather than what I would like to be. For more on this particular personal philosophy, you might like to read “How I found Freedom in an Unfree World” by the late US libertarian, Harry Browne.
With that said, if you’re open to the idea of buying shares in a tobacco company…
One of the most compelling investment opportunities I see in
Asia right now is HM Sampoerna, Indonesia’s best managed tobacco company
The company is one of the biggest employers in its home city, Surabaya, and makes a huge contribution to the regional economy.
Sampoerna is a subsidiary of PT Philip Morris Indonesia and an affiliate of Philip Morris International Inc., one of the world’s leading tobacco companies and owner of the famous Marlboro brand.
Phillip Morris acquired the stake of Sampoerna’s founding family back in 2005 and now holds 92.5% of the company’s shares.
But Indonesia’s stock exchange and company laws don’t have a provision for a majority owner to be able to “compulsorily acquire” the last remaining shares of a company not tendered into a takeover bid.
In most countries, if one shareholder owns 90% or more of a listed company’s stock, they can force the recalcitrant 10% to sell to them too, and then delist the stock. That’s not possible in Indonesia.
Instead, HM Sampoerna remained listed on the Jakarta Stock Exchange, with a very small, “free float” for many years. That’s lucky for us. It allows us to buy into a business that’s so good, in most instances it would have been taken private long ago.
In 2015, in order to boost the free float, and not run afoul of the stock exchange listing rules, which require at least 7.5% of an Indonesian listed company’s shares to be owned by the public, Sampoerna conducted a rights offer. It allowed existing shareholders to buy more shares at a price of Rp 3,080 (Rp 77,000 adjusted for a subsequent 25 for 1 stock split in 2016).
Contrast that with the current stock price of Rp 1,685 and you can see that it’s worth examining closely whether this might not be the sort of bargain Global Value Hunter seeks out for investment.
What matters is not the stock price, per se. What we want to know is, is the stock price cheap relative to the likely future earnings stream of the company, the free cash flow it will generate, and the dividends it will pay out?
The answer is a resounding yes.
I have bought shares in HM Sampoerna and I’m looking to acquire more.
The stock currently trades at a price-earnings multiple of 14 times. It trades on a dividend yield of 6.8%. Those are good, but not great numbers from a value hunter’s perspective. That said, thanks to the coronavirus pandemic, they are historically some of the most attractive multiples Sampoerna has ever traded at.
What makes this a great investment is you are buying shares in a “wonderful business” at a fair price. Sampoerna has several dominant brands in an industry selling one of the most addictive products known to man, in the country with the highest level of smoking addiction among adult males anywhere in the world, which is a market of over 280 million people.
Because of its business “moat” and favourable product and market characteristics, Sampoerna’s return on equity (ROE) is an impressive 35.4%.
That means that for each dollar employed in the business, Sampoerna generates 35.4 cents of profit each year.
Even more impressive is that it achieves this without employing any long-term debt. The company’s balance sheet is like a fortress.
You can currently buy shares at a multiple of 5.1 times equity (or book value).
Divide ROE by P/B, and you get 6.95%.
That approximates the annual return on your capital invested at the current share price. All else equal, at that rate, you double your money roughly every 10 years and 4 months.
I view this as being almost akin to a long-term bond investment where both your coupon and the principal grows over time.
I already own a small position and I am accumulating more shares.
I will probably never sell my Sampoerna shares. They will pass to my Indonesian daughters. This is a company likely to be around and dominating its market for generations to come. It’s a true compounding machine.
If you’re more of a short-term trader, even if the stock only goes halfway back to its old peak of Rp 4,300 – which I fully expect to happen in the next bull market cycle – you’re looking at a 77% gain.
P.S. If you need a suggestion for a broker that can buy these shares, I can provide one. Send me a note at firstname.lastname@example.org. The broker I use is based in Asia, but not in Indonesia. It’s possible to open an account with them entirely online, though you do have to mail the forms in, from memory. There is also a listing for Sampoerna on the OTC “Pink Sheets” market in the USA from what I can see.