Neptune’s Robin Geffen believes the ‘game is over’ for big name tobacco brands as they struggle to find markets for growth and offer little dividend cover.
The Neptune Investment Management founder, who manages the £209.6 million Neptune Income fund, said: ‘In mature markets round the world, tobacco sales are falling and will continue to fall.
‘In emerging markets, so places like Indonesia and Vietnam, which these companies would assume would be their growth areas, that’s where the damage is happening now.
‘Politicians no longer smoke on television. You buy packets of cigarettes there, they are starting to have health warnings on them. The game is over.’
Geffen acknowledged tobacco stocks had historically delivered ‘brilliant’ returns for income investors over the last two decades, but said they were struggling to keep up with a changing market.
E-cigarettes, or ‘vaping’, has been seen as a way for tobacco companies to replenish revenues lost by declining tobacco use, but Geffen argued traditional tobacco companies like British American Tobacco (BATS) or Imperial Brands (IMP) were falling behind the likes of $15 billion Israeli vaping product manufacturer Juul.
Nor could vaping be seen as the silver bullet for the sector, given increasing regulatory pressures, particularly in the US, where Food and Drug Administration commissioner Scott Gottlieb has called the rise in vaping among young people an ‘epidemic’.
‘So when they say to you the future lies in vaping, they’re not going to make any money out of vaping,’ said Geffen.
‘It doesn’t surprise me the Imperial Brands’ chief executive said that she was considering buying a Canadian cannabis company,’ he added, but claimed that move would be plagued with difficulty.
‘All you could possibly sell is cannabis oil as some kind of medical treatment if you have the licenses but are hospitals in the UK going to sign up to buy cannabis oil from a tobacco company? I don’t think so,’ he stated.
Shares in BAT and Imperial have lagged since the turn of the year, down 29.6% and 16.2% in 2018 respectively.
While that has boosted the yields of both, to 5.5% and 6.5%, dividend cover, the ratio of their earnings to what is paid out in dividends, is thin, at 1.6 times and 0.8 times.
Despite that, the two tobacco stocks account for around 7.4% of the yield of funds in the Investment Association’s UK Equity Income sector, according to Neptune’s calculations.
Geffen (pictured) said this ‘dividend risk’ permeated the sector, as funds relied on a concentrated number of stocks to produce fund yields.
According to Neptune’s research, a quarter of UK equity income funds rely on one company to deliver more than 10% of their yield.
Around three-quarters funds in the sector deliver more than 40% of their yield from their top 10 holdings, according to Neptune.
Geffen argued rival funds were vulnerable to dividend cuts, with the average stock held in UK equity income managers’ top 10 investments offering dividend cover of 1.5 times, and 42% of the sector’s yield coming from companies where dividends are uncovered by earnings.
‘It doesn’t take much of a shock, much of hit from politics, the economics, Brexit, a change in government, for that to go into really dangerous waters,’ he said.
He used the example of ‘catastrophe stocks’ such as Provident Financial (PFG). The doorstop lender scrapped its dividend last year, as it announced the departure of its boss, revealed an FCA investigation into a key product and delivered a profit warning, sending its shares crashing.
That dealt a blow to major investors like Neil Woodford and Mark Barnett. Woodford held 4.6% of his Woodford Equity Income fund in the shares at the time of the dividend cut, while Barnett’s Invesco Perpetual Income and High Income funds held 2.8% positions.
Geffen highlighted the high ‘dividend risk’ of funds in the UK Equity Income sector, a term Neptune applies to the percentage of a fund’s yield derived from a fund’s top 10 holdings.
This stands at an average of 44.7% across the sector, and Neptune highlighted the JOHCM UK Equity Income fund as one at the upper end of the spectrum, with 59.6% of its yield coming from the portfolio’s top 10.
Geffen spreads his income generation across the portfolio of his Neptune Income fund in an unusual way, by holding an equal weighting of around 3% in each of the 33 stocks held.
The fund is up 38.9% over three years to the end of September, ahead of an average return of 25% from funds in Citywire’s UK Equity Income sector.