Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisenthal and I'm Tracy Alloway. Tracy, you know,
Speaker 1: one thing that sort of characterizes the stock market these
Speaker 1: days is just this incredible dominance of a handful of
Speaker 1: gigantic tech companies. I mean, you pointed out today, I
Speaker 1: think you tweeted a chart this morning just showing how like,
Speaker 1: if you exclude just a handful of like five companies
Speaker 1: or whatever, the spire is basically going nowhere. Yeah, that's
Speaker 1: exactly right. So I think it's if you exclude Facebook, Amazon, Apple, Microsoft,
Speaker 1: and Google and just look at the remaining foes in
Speaker 1: the spire, the index is actually down one so far
Speaker 1: this year. And if you only look at those five
Speaker 1: tech stocks, those are up forty or almost forty this year,
Speaker 1: which is phenomenal. And because they're such a huge part
Speaker 1: of the index, of course, they pull the whole thing
Speaker 1: up to about six percent year today. What do you
Speaker 1: think about those articles you're a journalist, what do you
Speaker 1: think about those articles that are like, oh, if you
Speaker 1: had invested, you say that like you're not, Oh you're
Speaker 1: What do you think about those articles that are like, oh,
Speaker 1: if you had invested like a hundred dollars at Apple's,
Speaker 1: I p o, you would be like this rich by Now,
Speaker 1: would you ever commission a story like that? I don't
Speaker 1: think I'd commissioned them, but I can see I can
Speaker 1: see why people keep writing them. I mean, hindsight. Hindsight
Speaker 1: articles are often a draw, and I think I think
Speaker 1: there are quite a few things that you could find
Speaker 1: where you could say, oh, well, have you invested a
Speaker 1: dollar in this, You'd now be a millionaire or even
Speaker 1: a billionaire. And some of them are really surprising. So
Speaker 1: I think we spoke about Domino's Pizza once. I mean,
Speaker 1: there are stocks like that that you wouldn't necessarily expect
Speaker 1: to outperform in that way. Right, here's a crazy stat um.
Speaker 1: If you had invested one dollar in tobacco stocks in
Speaker 1: your nineteen hundred, which you know no one alive today,
Speaker 1: I don't think we could have done that. Do you
Speaker 1: know how much it would be worth today? I do,
Speaker 1: not one dollar? Supposedly, according to this thing I'm reading
Speaker 1: right here, six point three million dollars if you had
Speaker 1: invested in tobacco stocks in Oh, darn, I missed that opportunity.
Speaker 1: But yeah, I mean tobacco stocks. Tobacco stocks kind of
Speaker 1: fits under the Domino's Pizza model of unexpected outperformance, because
Speaker 1: when you think about tobacco stocks, you think about all
Speaker 1: these pressures and headwinds that have been on the business
Speaker 1: model for for decades now, right, Yeah, mean basically since
Speaker 1: we've been alive, or since uh you know, yeah, since
Speaker 1: we've been alive, we've mostly known tobacco as the sort
Speaker 1: of vilified industry. All sorts of public health efforts to
Speaker 1: get people to stop smoking, taxes on cigarettes, to discourage consumption,
Speaker 1: lawsuits and so forth. And yet you know, sure, you
Speaker 1: have some noise here and there, and I think maybe
Speaker 1: in the last couple of years they haven't done as well,
Speaker 1: but by and large, tobacco companies cigarette companies have just
Speaker 1: been extraordinary winners for years and years and years, even
Speaker 1: with all of these sort of efforts to slow them down. Yeah,
Speaker 1: so I think this is a really interesting industry to
Speaker 1: focus on at the moment um. Even though we're talking
Speaker 1: about things that happened to tobacco over the past one
Speaker 1: hundred years or so, you can see there's there's definitely
Speaker 1: parallels between tech and makers. I guess because government policy
Speaker 1: played such a role in the tobacco industry, and we're
Speaker 1: starting to see I think the beginnings of government policy
Speaker 1: really come into play for the big tech companies as well.
Speaker 1: And I think people even called like I've seen people
Speaker 1: say things like, oh, Facebook is the new tobacco or whatever.
Speaker 1: They usually mean that negatively, but if you took it
Speaker 1: literally from an investment standpoint, that's like, oh, that I
Speaker 1: should definitely find. Yeah, there's definitely tension there between um,
Speaker 1: it being a complete moneymaker and also people saying it's
Speaker 1: a negative for society. Right, So, anyway, today we're going
Speaker 1: to talk about tobacco stocks in general and why they've
Speaker 1: done so well, and not just tobacco stocks, but tobacco companies,
Speaker 1: and what it is sort of unique about this industry
Speaker 1: that for decade after decade after decade, year after year,
Speaker 1: and despite all these head winds, they've just been extraordinary
Speaker 1: money Maker's very hard to disrupt them bring them down
Speaker 1: in any way. We're going to be talking with two
Speaker 1: guests today. Gene Hoots. He's an investment advisor and he's
Speaker 1: the author of a book, Going Down Tobacco Road. R. J.
Speaker 1: Reynolds Tobacco Empire, The gold Leaf in North Carolina. And
Speaker 1: Lawrence Hampton he's also an investment advisor and UH follow
Speaker 1: him on Twitter. He's talked a lot over the years
Speaker 1: about tobacco stocks and about what makes them unique. And
Speaker 1: Gene and Lawrence. Uh they did a Q and A
Speaker 1: on there on Lawrence's blog a few weeks ago about
Speaker 1: the industry and I thought it was super interesting and
Speaker 1: I thought we should expand on it here. So very
Speaker 1: excited to learn more about these about tobacco companies with
Speaker 1: these two. Uh, So let me bring them in one
Speaker 1: at a time. Lawrence, thank you very much for joining us. Hey,
Speaker 1: thanks guys, Thanks appreciate the opportunity. And U Gene, I
Speaker 1: really appreciate you coming here as well and talk about
Speaker 1: your book. Thank you. It's a pleasure to be here.
Speaker 1: I guess one of you will be talking about your
Speaker 1: literal book and one of you will be talking your
Speaker 1: book so to speak. But no, seriously, you know, let's
Speaker 1: kick it off. I mean, Lawrence, I followed you for
Speaker 1: a long time. I know you sort of regularly point
Speaker 1: out what an extraordinary industry this has been from a
Speaker 1: sort of investment standpoint. When did you sort of start
Speaker 1: paying attention to tobacco stocks is sort of like their
Speaker 1: own almost their own asset class. What got you interested
Speaker 1: in them? I think when I started in the industry
Speaker 1: in two thousand two and started to manage other people's
Speaker 1: money and two thousand five and uh, sort of a
Speaker 1: contrarian by nature, and I was heavily influenced by people
Speaker 1: like David Dreaman and Peter Lynch and and both of
Speaker 1: those guys talked at length about tobacco stocks and what
Speaker 1: was seemingly they're perpetually cheap valuations at that point in
Speaker 1: time and the early two thousand's that was really sort
Speaker 1: of a contrarian play. They were just coming out of
Speaker 1: the Master Settlement Agreement, the lawsuits, things like that. Valuations
Speaker 1: were depressed div it in you olds were in the
Speaker 1: double digits, and you they really were facing kind of
Speaker 1: a bankruptcy threat at that point in time. And and
Speaker 1: so if you really looked at the businesses, you could
Speaker 1: see they were still making money despite all the negative headlines.
Speaker 1: And if you dig a little a little deeper, you
Speaker 1: understand the dynamics of the industry. Or almost unlike any
Speaker 1: other if you look at Ken French's website, he has
Speaker 1: industry data going back to the twenties, and as far
Speaker 1: as I can tell, there's never been a negative ten
Speaker 1: year period in total return for the tobacco industry. That's
Speaker 1: unlike just about any other you talk with with Tracy
Speaker 1: about this hypothetical time machine of going back and investing money,
Speaker 1: Um and some big winner, and if you look at it, Microsoft,
Speaker 1: all these big tech companies. I think at some point Apple,
Speaker 1: they suffered through uh fairly long periods in the wilderness,
Speaker 1: so to speak. But tobacco for the most part, really hasn't.
Speaker 1: I mean, if you had invested that money at any
Speaker 1: point in time over the past one years, you probably
Speaker 1: would have had a decent outcome over the subsequent decade.
Speaker 1: So it's really been a fascinating industry. And I followed
Speaker 1: it for a long time. I think our clients have
Speaker 1: been invested in it for fifteen and sixteen year or
Speaker 1: something like that. So Lawrence has been following the industry
Speaker 1: and Gene you were actually in the tobacco industry, and
Speaker 1: of course you've written this book about your experience. Can
Speaker 1: can you maybe in a nutshell tell us Um what
Speaker 1: exactly you were doing at tobacco firms and do you
Speaker 1: agree with Lawrence that the business is uh special in
Speaker 1: many ways. First of all, I certainly agree with that
Speaker 1: it it has been a special industry, and thinking about
Speaker 1: that industry is what prompted me to write the book.
Speaker 1: I grew up in tobacco country. I'm a native North
Speaker 1: Carolinian and didn't realize how much tobacco had always been
Speaker 1: a part of my life until I started this book.
Speaker 1: But I worked twenty year twenty one years for R. J.
Speaker 1: Reynolds in Western Salem. I was in the financial area
Speaker 1: one way or another, mergers and acquisitions for a while,
Speaker 1: and in the last ten years I ran the pension
Speaker 1: and profit sharing and four oh one K plans worldwide
Speaker 1: managing those moneys. So I was of the tobacco industry,
Speaker 1: but not in it. I looked at the company as
Speaker 1: more or less an analyst would from outside so often
Speaker 1: and dealt with the tobacco analysts and talked with them
Speaker 1: about it. So that gave me a little different perspective
Speaker 1: than most people in the company. And after thirty years
Speaker 1: I decided to sit down and write this book. The
Speaker 1: key event in the life of R. J. Reynolds and
Speaker 1: and Winston Salem as well, the home of off J.
Speaker 1: Reynolds was the leveraged buy out by k k R
Speaker 1: in early eighty nine. That was a seminal event in
Speaker 1: the life of the company, and I built my story
Speaker 1: around that. Why did that happen? Why I was there
Speaker 1: buy out, what led up to it, and then what
Speaker 1: followed it? And I was interested to see, just as
Speaker 1: Lawrence has already mentioned, through all of those good times
Speaker 1: and bad of corporate raiders, mistakes and acquisitions that Reynolds
Speaker 1: made that were misdirected, perhaps the tobacco industry just rode
Speaker 1: right along, generating a return on equity of somewhere between
Speaker 1: picking number fourteen and a half the nineteen percent year
Speaker 1: after year after year. There's a lot to dig into,
Speaker 1: and the question, of course, is why has the industry
Speaker 1: been able to um, you know, continue to create this
Speaker 1: return on equity for so long. We'll get to these
Speaker 1: sort of legal headwinds and the other attempts to slow
Speaker 1: down the industry that public health officials have undertaken over
Speaker 1: the years, but you know, it just sort of that aside.
Speaker 1: You're like, look at a the are we of the industry,
Speaker 1: and you're like, well, okay, why didn't have an more
Speaker 1: competitors come in and squeezed those results. How why haven't
Speaker 1: margins come down? Why hasn't there been a price war?
Speaker 1: Let's start with that question. Either one of you could
Speaker 1: take it or both of you. Why hasn't this extraordinary
Speaker 1: outperformance resulted in more competition in the therefore poorer performance.
Speaker 1: One simple explanation is the performance has been great, but
Speaker 1: the industry has been losing customers all along. And uh,
Speaker 1: you know Peter Lynch and one of his books talks
Speaker 1: about the comparison between Philip Morris and Xerox, and Xerox
Speaker 1: was kind of the sexy growth stock and the sixties,
Speaker 1: and that was kind of the point at which smoking
Speaker 1: started to fall out of favor, when the health health
Speaker 1: risks became well known, and so Xerox ended up attracting
Speaker 1: a lot of competitors. And Uh, on the other hand,
Speaker 1: tobacco which started to lose clients. I think smoking is
Speaker 1: down and percentage terms over the last fifty years. Why
Speaker 1: would you want to get into that industry? It's it's
Speaker 1: a declining industry of multi ice cube, so to speak.
Speaker 1: So uh, like Peter LYNCEI, a shrinking industry doesn't attract
Speaker 1: much competition, it's better to be sort of the dominant
Speaker 1: player and a slow growth or no growth industry and
Speaker 1: customer terms. Looking back a long term, I think there's
Speaker 1: a number of things that brought the tobacco industry to
Speaker 1: a few key players today. It took a long time
Speaker 1: to get there, and the industry doesn't want to talk
Speaker 1: about it. But I truly believe the basic thing that
Speaker 1: brought all this, uh largest of the tobacco companies was
Speaker 1: the tobacco companies are setting an addictive product. It's fairly inexpensive,
Speaker 1: or has been relatively so throughout history. There's just a
Speaker 1: great interest and desire to have nicotine in one form
Speaker 1: or another. So they had a product, it was marketable.
Speaker 1: It really developed customers that were addicted to it over time,
Speaker 1: and the industry did not want to face that for
Speaker 1: a long time. I've talked to executives today and some
Speaker 1: of them said, we wished we'd have faced up to
Speaker 1: it and avoided the controversy years before we did. We
Speaker 1: still could have been in the business. So that's the
Speaker 1: first thing. I think that was an advantage that most
Speaker 1: businesses do not have. I would imagine that people are
Speaker 1: not addicted to Facebook, to the point that they couldn't
Speaker 1: find a competitive product to go to or a different
Speaker 1: website if they needed to. The tobacco industry, part of
Speaker 1: that was chance with the product. They had. Policies along
Speaker 1: the way over decades led to the fact that there
Speaker 1: were only a few people participating in the business. As
Speaker 1: Lawrence said, there's not a real interest in joining it
Speaker 1: now but government policies. But one of the major ones
Speaker 1: was when the advertising of tobacco was outlawed, first on
Speaker 1: television then from billboards. That made it all most impossible
Speaker 1: for new entrants to come in. No matter how profitable
Speaker 1: the business was, you just couldn't afford to build a
Speaker 1: cigarette plant, and there was no way to mount a
Speaker 1: marketing and distribution campaign for a new cigarette. A new
Speaker 1: cigarette would have been quite profitable for anybody who could
Speaker 1: do it, but it just wasn't worth the risk. Smokers
Speaker 1: are very, very loyal to the brand, and it's very
Speaker 1: hard to get him to change. Could I give you
Speaker 1: one brief anecdotal example of that. Yeah, I just I
Speaker 1: just had this conversation the other day with a young
Speaker 1: man I'd never met him, and his his grandfather was
Speaker 1: a major executive with R. J. Reynolds, and he said
Speaker 1: that his his grandmother, who ultimately died of lung cancer,
Speaker 1: was a devoted camel smoker, and when she found that
Speaker 1: Reynolds was going to make a filtered product, she declared
Speaker 1: that a filter would never touch her lips, and she
Speaker 1: went out and bought all. They didn't. They did not
Speaker 1: discontinue the manufactur of camels sixty millimeter regulars, but she
Speaker 1: thought they might. She went out and bought as many
Speaker 1: camels as she could build her freezer with them so
Speaker 1: that she would have a lifetime supply because she didn't
Speaker 1: want to switch brand. That's how there's ore their product.
Speaker 1: The Marlborough Cowboy people just as loyal Tomorrow Burrows believe me,
Speaker 1: all right. So you have an addictive products where brand
Speaker 1: loyalty really matters. But advertising is also what is important.
Speaker 1: Because of the brand loyalty aspect, you need to build
Speaker 1: up that following. Once you have it, you're basically guaranteed
Speaker 1: guaranteed to keep those customers. Could you maybe described in
Speaker 1: a bit more detail how the industry whittled down to
Speaker 1: just a handful of major players, because I imagine in
Speaker 1: the nineteen hundreds when you could have invested that one
Speaker 1: dollar in a tobacco for it wouldn't happen. Clear which
Speaker 1: tobacco firm you should invest in, there probably be quite
Speaker 1: a few around, right. What was the industry like, back like,
Speaker 1: back then, and how did it evolve exactly to the
Speaker 1: point where we have two or three major players. Well,
Speaker 1: let's look at nineteen hundred or thereabouts, there were hundreds
Speaker 1: of chewing tobacco products. There were very few cigarettes sold
Speaker 1: at the turn of the last century. Cigarettes did not
Speaker 1: become nationally popular until about the time of World War One.
Speaker 1: People had chewing tobacco, they had snuff, smokeless tobaccos, and
Speaker 1: pipe tobaccos. But the thing that changed things was primarily
Speaker 1: around the turn of the century, James buck Duke created
Speaker 1: the American Tobacco Trust, and that was the consolidation of
Speaker 1: the industry. So that alone consolidated most of the tobacco
Speaker 1: companies and to three or four major comps. You had
Speaker 1: American Tobacco, you had Ligot, Meers, R. J. Reynolds, and
Speaker 1: that was about it. Philip Morris had a piddling market
Speaker 1: share at that point. So the breakup of the Tobacco
Speaker 1: Trust and by by Teddy Roosevelt's anti trust measures created
Speaker 1: four or five major players in in in that era.
Speaker 1: That was partly a result of government policy that created
Speaker 1: just that group. And then the tobacco industry really took
Speaker 1: off in nineteen thirteen, and that that is the cigarette
Speaker 1: part of it. Again, there was no there were no
Speaker 1: real national brands. R. J. Reynolds introduced the first national brand, Campbell,
Speaker 1: in nineteen He was a he was a genius at
Speaker 1: advertising and promotion, and he had a good product, so
Speaker 1: he brought that out. The too. Other tobacco companies, Ligot
Speaker 1: Meers and American realized they had to have a competitive product,
Speaker 1: so they brought out Chesterfield and Lucky Strike. Those three
Speaker 1: dominated the market. Then what really propelled the market forward
Speaker 1: was World War One. The dough Boys went overseas h
Speaker 1: Perishing declared that they needed cigarettes in order to win
Speaker 1: the war, and so we developed through gift of cigarettes
Speaker 1: to the World War One boys overseas, we developed a
Speaker 1: national market. When they came home, we had a whole
Speaker 1: generation of people who now smoked cigarettes and were loyal
Speaker 1: to those three brands. And that was the beginning. This
Speaker 1: was repeated in World War Two all over again. And
Speaker 1: so you've built a market that way, and that's that's
Speaker 1: how you by chances as well as designed. You were
Speaker 1: limited to three or four or five major players. Philip
Speaker 1: Morris was a special case. They they were people who
Speaker 1: came later with a stroke of genius with the mar
Speaker 1: Borre a cowboy. I think that was partly genius and
Speaker 1: partly luck. They were there at the right time, and
Speaker 1: they they undoubtedly used that opportunity to build their market
Speaker 1: share and grow like crazy, and they were uh well
Speaker 1: rewarded for it. The stockholders were. It's it's been the
Speaker 1: premier cigarette company ever since the about about nine when
Speaker 1: they took off. So um, you know, it's interesting you
Speaker 1: mentioned the you know, how many different ways people consumed
Speaker 1: tobacco a hundred years ago, and cigarettes were in this
Speaker 1: big Obviously, these days there are a plethora of other
Speaker 1: alternatives and so we don't really see new cigarette startups
Speaker 1: per se, but we have seen a lot of companies
Speaker 1: come into other delivery mechanisms, most notably vaping. Jewel was
Speaker 1: extremely big, although I think they've run into some trouble
Speaker 1: in recent years. We also see states taking a more
Speaker 1: liberal attitude towards consuming cannabis, pretty much all over the country.
Speaker 1: How do these uh factor into thinking about the competitive risks?
Speaker 1: Is this a new phase where they're actually are sort
Speaker 1: of new entrant that could theoretically compete for you know,
Speaker 1: mouth share. I guess I don't know what term you
Speaker 1: use in a way that we haven't really seen before.
Speaker 1: I would just say I think there's that possibility. But
Speaker 1: the the threat to those things that always seems to
Speaker 1: be hanging over them is is FDA regulation UM jewels
Speaker 1: having to go through that process now to get approved UM.
Speaker 1: I think Philip Morris International with i q os is
Speaker 1: the only device that has uh FDA approval for marketing
Speaker 1: their their product as is kind of a safer alternative,
Speaker 1: if I'm not mistaken. It's still a very difficult market
Speaker 1: to to break into in a big way. There certainly
Speaker 1: are a lot of new methods. A Swedish match has
Speaker 1: a new nicotine product that's a kind of an oral
Speaker 1: product that that is kind of another competitor to chewing
Speaker 1: tobacco and smoking and so forth. There there are a
Speaker 1: few things that are coming in, but almost with the
Speaker 1: brand loyalty, people still have their their preferences, and I
Speaker 1: think there are also some cultural differences. What appeals to
Speaker 1: smokers in Japan as an alternative, for example, may not
Speaker 1: necessarily appeal to Americans. So it remains to be seen
Speaker 1: just how popular vaping gets to be. It It certainly
Speaker 1: does present a little bit of competition, but on the
Speaker 1: other hand, a lot of these companies have their own
Speaker 1: vaping products, so it just seems to me the most
Speaker 1: likely outcome is is that they will continue to dominate
Speaker 1: the nicotine space for lack of a better term, whether
Speaker 1: it's through combustibles, uh oral or or vaping in some
Speaker 1: fashion or another, simply because it's it's just very difficult
Speaker 1: to get your product there, get it approved. You've seen
Speaker 1: different states take different laws against vaping, but of course
Speaker 1: they are the most part still allow combustibles but tax
Speaker 1: them heavily. I just think it's going to be a
Speaker 1: very tough nut to crack for a lot of these
Speaker 1: alternative delivery mechanisms to take a a very big share
Speaker 1: of the nicotine market. I'm curious we talked about how
Speaker 1: tobacco stocks would have been a really good bye a
Speaker 1: hundred years ago. Would either of you recommend them as
Speaker 1: an investment now? And I'm going to add a disclaimer
Speaker 1: here that you know, no one on all thoughts is
Speaker 1: officially recommending any stock spot. I'm curious would you say
Speaker 1: they are a good investment given some of the headwinds
Speaker 1: in competition that you just described. Well, I will just
Speaker 1: say that in full disclosure, both personally and client portfolios,
Speaker 1: we we do have positions and the major tobacco names,
Speaker 1: so obviously we we do think that they have rewarding
Speaker 1: or potential going forward. The last few years have definitely
Speaker 1: been been tough, although I would argue almost all of
Speaker 1: that share price under performance has been multiple contraction. You've
Speaker 1: seen Altriaz, which is the domestic Philip Morris, You've seen
Speaker 1: their multiple go from the low twenties to the high
Speaker 1: single digits, although they've continued to raise their dividend year
Speaker 1: after year and increase their earnings. Uh. In my mind,
Speaker 1: that's just uh, And that really stem from I think
Speaker 1: in two thousand seventeen when the f d A sort
Speaker 1: of threatened to limit the amount of nicotine and and cigarettes,
Speaker 1: and so far really nothing has happened in that space,
Speaker 1: but it's certainly sort of returned to investors minds the
Speaker 1: idea of heightened regulation, which really hadn't been there in
Speaker 1: a while. Certainly, I think that even though it is
Speaker 1: a shrinking industry, the potential for the overall nicotine market
Speaker 1: is still relatively large. And I do think there will
Speaker 1: be some things that will happen going forward. But but yes,
Speaker 1: I do think that that they will eventually return to favor.
Speaker 1: But you know, as you pointed out earlier, everybody is
Speaker 1: kind of on the tech side of things. Some of
Speaker 1: these other industries are are out of favor, but that
Speaker 1: tends to happen in cycles, and I do think they'll eventually,
Speaker 1: um come back in favor. I took my analysts head
Speaker 1: off years ago, so I'm not about to try to
Speaker 1: uh add anything to to what Lawrence has said on that.
Speaker 1: But let me give you a little historical perspective on
Speaker 1: the so called nicotine delivery system. That was a term
Speaker 1: that was coined by a dear friend of mine, Dr
Speaker 1: Claude Tigue, who was in research at r j R.
Speaker 1: He wrote an internal memo about that that was strictly
Speaker 1: an academic or research product. It it made it to
Speaker 1: the to a congressional investigation and became a buzzword from
Speaker 1: that point on. But there has been a desire for
Speaker 1: a nicotine delivery system since about the late fifteen hundreds,
Speaker 1: and it got it picked up steam in England and
Speaker 1: all over Europe when Sir Walter Raleigh introduced it throughout Europe.
Speaker 1: There's been a love hate relationship between governments and nicotine
Speaker 1: ever since. Uh. It's interesting that the first anti smoking
Speaker 1: campaign was waged by Czar Alexis in Russia in the
Speaker 1: mid sixteen hundreds. He had fairly severe finds. The first
Speaker 1: defense for smoking was a slit nose and transferred to Siberia.
Speaker 1: The second time they caught you smoking it was the
Speaker 1: death penalty. He still wasn't able to stamp out the
Speaker 1: tobacco urge the people had. And what what governments and
Speaker 1: kings and queens and czars learned after that was, look,
Speaker 1: we can make a lot better deal here by taxing
Speaker 1: this product and we can't trying to stop it. And
Speaker 1: that's been going on ever since, bringing that all the
Speaker 1: way through to the Master Settlement Agreement. I was aware
Speaker 1: of the agreement. I knew something about it, but I
Speaker 1: was dumbfounded when I looked at the numbers. When you
Speaker 1: go through the settlement agreement that was made, there were
Speaker 1: a number of stakeholders that now become vested interest holders
Speaker 1: in the continuation of the cigarette business. And you have
Speaker 1: federal excise taxes, state exercise taxes, payments to the f
Speaker 1: d A, payments to the farmers, payments of billions of
Speaker 1: dollars to the lawyers who brought those class action suits.
Speaker 1: When you add it all up, and from from the
Speaker 1: time that it started about nineteen, I guess that was
Speaker 1: what eighty nine I think ninety nine whichever, fifty projecting
Speaker 1: those numbers fifteen fifty years forward, the tobacco industry was
Speaker 1: on the hook for one seven trillion dollars of payments
Speaker 1: over that period of time. How did they address this?
Speaker 1: If you looked at that outside and looked at that
Speaker 1: astounding number and say, my heavens, this is gonna break
Speaker 1: the industry, you know what they did. They said, we
Speaker 1: can cover this, will raise cigarettes forty five cents a pack.
Speaker 1: That covered their bills to all these outside people and
Speaker 1: gave a little increased profit margin Beside that's the nature
Speaker 1: of the business talk. I'm fascinating by that because you know,
Speaker 1: I mentioned, like my whole life, I've been uh feeling
Speaker 1: the public health and lawyers and everyone going after this industry.
Speaker 1: So I'm the master settlement agreement was in the late nineties.
Speaker 1: Talk a little bit more about how that came about,
Speaker 1: and then that point you made about the stakeholders, how
Speaker 1: suddenly there are a lot of interested parties, not just
Speaker 1: tobacco company shareholders, who want to see this industry continue.
Speaker 1: Talk about sort of how that, how that all came about. Well,
Speaker 1: it came about primarily through the the instigator and the
Speaker 1: leader in it. To give them credit from there for
Speaker 1: their creativity, was a group of lawyers down in Mississippi.
Speaker 1: They had successfully sued the asbestos manufactors and gotten something
Speaker 1: of a war test together, and that gave him an
Speaker 1: opportunity to go after other industries. And the tobacco industry
Speaker 1: was ripe for this. So they approached the states attorneys
Speaker 1: general of all of the states. And I'll simplify it
Speaker 1: because there were a feudal side deals here, But basically
Speaker 1: they went through this this suit and had a class
Speaker 1: action representing all the attorneys general, and it fell apart
Speaker 1: in Congress. They then came back and finally got together
Speaker 1: with the tobacco companies and made this agreement. That's how
Speaker 1: That's how it happened. There was a really interesting part
Speaker 1: of the settlement that I that I had not realized before.
Speaker 1: In all of the machinations within r j R. After
Speaker 1: the buyouts, CEOs change, a number of people came in
Speaker 1: and tried their hand at Ringing Tobacca Company and weren't successful.
Speaker 1: Of all the unlikely people that they brought in as
Speaker 1: the CEO was Steve Goldston, who was who was an
Speaker 1: attorney with r j R's outside council, Davis polk Wardwell,
Speaker 1: he came in as the CEO. He knew nothing. I
Speaker 1: can't say he knew nothing about the tobacco industry, but
Speaker 1: he had never worked in the tobacco industry. Gohold Stone,
Speaker 1: in my book, turned out to be one of the
Speaker 1: few really great heroes within a story that had a
Speaker 1: mixed message from from success. And he recognized finally as
Speaker 1: probably only an attorney could this ship is sail of
Speaker 1: trying to stone Wall and say there's no connection between
Speaker 1: cigarettes and cancer. He took that. He went to the
Speaker 1: other majors and said, look, if we contend, if you
Speaker 1: continue this approach, the government is going to run us
Speaker 1: out of business. We've got to come to terms here
Speaker 1: and that's what led to the Master Settlement agreement, was
Speaker 1: him bringing the industry to the table and some rationality
Speaker 1: I think, and willingness to compromise. They recognized they were
Speaker 1: going to have to do something along those lines. So
Speaker 1: we're talking about the public health concern and the government response,
Speaker 1: which obviously limited the creation of new customers. I'm curious
Speaker 1: in recent years we've seen another trend I guess or awareness,
Speaker 1: which is the the E s G movement in capital markets,
Speaker 1: so the idea that people should be investing in sustainable
Speaker 1: debt and equity. Do either of you feel that E
Speaker 1: s G has yet had an impact on the tobacco
Speaker 1: industry or is maybe limiting capital or affecting the cost
Speaker 1: of capital in some way. I'll just offer my my
Speaker 1: thoughts on that. It's it's very hard to to quantify
Speaker 1: in any way. I mean, you can always look at
Speaker 1: the the share price and whether some major institutions are
Speaker 1: forced to uh divest their their shares. Of course, somebody
Speaker 1: has to buy those shares them for the market to clear,
Speaker 1: so somebody will end up owning them. The trouble is
Speaker 1: that at what price, And it's it's very hard to
Speaker 1: say that that movement has has raised their cost of
Speaker 1: capital in any material way. For example, Altria pays out
Speaker 1: something like of its profits every year, so I'm not
Speaker 1: sure they need anybody's capital because they're too busy returning
Speaker 1: cash to their shareholders. And the same thing for I
Speaker 1: think be a T and and most of the other
Speaker 1: players the on the fixed income side, which is maybe
Speaker 1: the they have access the debt market in recent years,
Speaker 1: there's really no evidence that their interest rates or any
Speaker 1: higher than anybody else's of a similar balance sheet quality.
Speaker 1: So to me, it's it's a little bit tricky to
Speaker 1: try to say that that E s G is is
Speaker 1: really pressuring them in a financial way. Certainly they're aware
Speaker 1: of it. If you read through their commentaries, they are
Speaker 1: are trying to um get ahead of this movement and
Speaker 1: sort of market themselves. Philip Morris International talks about a
Speaker 1: smoke free future and what they're doing to to try
Speaker 1: to get their customers to pivot from combustibles too heat
Speaker 1: not burn and lower risk products. And so in a way,
Speaker 1: there's that sort of funny how they're appealing to the
Speaker 1: E s G crowd by saying that there they're actually
Speaker 1: trying to to do what's best for their customers by
Speaker 1: getting them to pivot to these other products. So I
Speaker 1: think they're aware of it. Whether or not E s
Speaker 1: G actually matters to their bottom line, I don't know.
Speaker 1: It probably matters more in terms of who ends up
Speaker 1: owning the shares, but that's about all I can make
Speaker 1: of it from what I've seen over the last few
Speaker 1: years of this movement sort of becoming sort of niche
Speaker 1: to more mainstream. Let me ask a sort of follow
Speaker 1: up question to Laurence um He s G aside. I'm
Speaker 1: just curious about the sort of conversations you might have
Speaker 1: with clients. They're probably people who uh, just feel uncomfortable
Speaker 1: investigate tobacco stocks, worried about owning a part of an
Speaker 1: industry that does lead to all sorts of adverse health
Speaker 1: effects and so forth. What are those conversations like as
Speaker 1: a financial advisor dealing with that aspect of it. Sure,
Speaker 1: so we we give our clients the ability to identify
Speaker 1: what they want to own a course and also what
Speaker 1: they don't want to own, And more than a few
Speaker 1: say that they would prefer not to own tobacco directly,
Speaker 1: and that's fine. We can work around that. The vast
Speaker 1: majority simply look at it from a more pragmatic standpoint,
Speaker 1: which is, where do you draw the line? So, are
Speaker 1: you going to own shares of Walmart or some sort
Speaker 1: of retailer that that sells these products? Are you going
Speaker 1: to look at it in a in a different standpoint
Speaker 1: that what's acceptable if you own an index fund, they
Speaker 1: own these shares. So really there's what are you doing
Speaker 1: other than making yourself sort of feel a little bit
Speaker 1: uh and I wouldn't say more really superior, but making
Speaker 1: yourself feel a little more comfortable and how you're invested
Speaker 1: just by not owning no shares directly. And I think
Speaker 1: most people recognize that they just want to invest in
Speaker 1: a way that that makes the money gives them an
Speaker 1: opportunity to achieve the returns that they need for their retirement.
Speaker 1: And so they end up sort of concluding that, uh,
Speaker 1: they're okay with with owning a small stake in a business,
Speaker 1: and they're not as on a secondary market. They're not
Speaker 1: giving the money directly to the company, simply receiving their
Speaker 1: share of the profits via dividends or what have you,
Speaker 1: and they're free to take that money and do with
Speaker 1: it what they want, whether it's donating to h anti
Speaker 1: smoking campaign or whatever. So we we have those conversations,
Speaker 1: we sort of lay it out and uh uh in
Speaker 1: a certain fashion that says, okay, well, if you exclude these,
Speaker 1: here's the reason why, here's what you may considering. If
Speaker 1: they still decide to exclude it, that's certainly fine. But
Speaker 1: we just want to make sure that they understand all
Speaker 1: the different angles and and uh see it through that way.
Speaker 1: This attitude on tobacco, I think comes and goes. I
Speaker 1: really I think this is right. I remember not being
Speaker 1: directly related to it, but reading an article about it. Calper's,
Speaker 1: the big pension fund in California, divested themselves of tobaccos
Speaker 1: for some period of time, and then I think I
Speaker 1: read an article in the journal that they had decided
Speaker 1: they had made a mistake and they were going to
Speaker 1: reinvest in tobacco's talks after tobacco stocks at such a
Speaker 1: great performance for four or five years. I have a
Speaker 1: slightly weird question, and I'm not sure either of you
Speaker 1: will be able to answer it, but we mentioned cannabis
Speaker 1: earlier in this episode. To what extent do the economics
Speaker 1: of the cannabis industry resemble the economics of the tobacco
Speaker 1: industry in the sense that, you know, you you have
Speaker 1: a product that people really like. Um, you have you're
Speaker 1: growing a crop essentially, which is similar to tobacco. Could
Speaker 1: you see the cannabis industry following along the lines of
Speaker 1: the tobacco industry if, for instance, you know, tomorrow the
Speaker 1: federal government decided to legalize marijuana across the United States,
Speaker 1: would it take off? And would it resemble tobacco? Others
Speaker 1: offer some thoughts on that, which is and I this
Speaker 1: is this pure conjecture on my part. I actually think
Speaker 1: ink and this is just based on my conversations with
Speaker 1: people who knew a little bit more. Is that I
Speaker 1: almost wonder if the cannabis industry will not more closely
Speaker 1: resemble the alcohol industry and not the tobacco in the
Speaker 1: sense that, um, the side effects of excess alcohol consumption
Speaker 1: more closely resemble cannabis consumption in some ways. And I
Speaker 1: think that some alcohol companies have identified cannabis as a
Speaker 1: threat to their UH bottom line. And I want to
Speaker 1: say that a few companies have actually made investments in
Speaker 1: cannabis to sort of hedge that that risk. Me at
Speaker 1: this point, it seems a little more fragmented. Uh, there's
Speaker 1: not too many established players. It's it's not at all
Speaker 1: clear how profitable their operations have become. I want to
Speaker 1: say that maybe Gene can correct me that the tobacco
Speaker 1: companies were profitable from day one and and really had
Speaker 1: there wasn't much speculation, uh in that space. To me,
Speaker 1: it seems like there's quite a bit of speculation in cannabis.
Speaker 1: So I don't know if that helps at all, but
Speaker 1: but I would say maybe the better comps as the
Speaker 1: alcohol industry for cannabis, not tobacco. Historically, You're right, the
Speaker 1: tobacco industry was amazingly profitable from the very beginning, way
Speaker 1: back in the just post Civil war. It started with smoking,
Speaker 1: with with chewing and smoking the pipe, smoking tobacco's and
Speaker 1: it was profitable from the from the very beginning and
Speaker 1: has continued to be. So if I could just offer
Speaker 1: my take on what an investor should look for going forward,
Speaker 1: and I don't know what the companies are gonna do,
Speaker 1: but the thing I would be looking for from the
Speaker 1: cigarette companies is to face the reality. And I've made
Speaker 1: this analogy before, the cigarette business with this declining base
Speaker 1: of of customers is not unlike an oil producering company,
Speaker 1: a company that's that's got oil wells and you're you're
Speaker 1: on a decline curve here of some dimension. The business
Speaker 1: is going away. The best thing I think that those
Speaker 1: companies can do is if they can find substitute tobacco
Speaker 1: products or tobaco products, that's fine. Otherwise, take that money
Speaker 1: that's being pumped out of the ground, if you will,
Speaker 1: in in my analogy, give it back to the shareholders.
Speaker 1: Don't try to reinvest it. As as Lawrences said, the
Speaker 1: cigarette companies don't need any more capital. You've got, they've
Speaker 1: got planned in place. They may need to modern rise occasionally,
Speaker 1: but the need for more fixed investment is not large.
Speaker 1: It simply is an enormous cash cow. What they do
Speaker 1: with that cash is going to determine, I think, how
Speaker 1: successful they will be as investments for the stockholders. This
Speaker 1: is where looking act R j R. Went down one path,
Speaker 1: Philip Morris went out another. Philip Morris was successful. They
Speaker 1: said they had a more abiding faith in tobacco than
Speaker 1: Reynolds did, and they stayed mostly in the tobacco business.
Speaker 1: They made a side venture into the foods business, which
Speaker 1: was pretty successful when they spun it off. R j R.
Speaker 1: Had an enormous number eight different industries, most of which
Speaker 1: did not work out very well. The reality was, I
Speaker 1: was stunned when I went through the numbers. Over of
Speaker 1: twenty six year period, we invested nineteen billion dollars in
Speaker 1: non tobacco industries. We got back eighteen billion dollars. Our
Speaker 1: return was minus one and a half percent a year compounded.
Speaker 1: Tobacco's profits hid all of those problems. They masked all
Speaker 1: of it, and the company continued to deliver about a
Speaker 1: thirteen and a half to fourteen percent a year compounded return.
Speaker 1: That's super interesting, that analogy to the oil well and declining,
Speaker 1: even throwing off tons of cash. You know, Before we
Speaker 1: go to wrap up, I want to go back. It's
Speaker 1: interesting comparing cannabis to alcohol because I want to ask
Speaker 1: a why haven't the economics of the alcohol industry been
Speaker 1: as strong as tobacco. Why hasn't it been this multidecade
Speaker 1: money printer in the same way in your view? And
Speaker 1: either one of you can answer, And then you know,
Speaker 1: just thinking about industries going forward. We sort of teased
Speaker 1: it um when I mentioned, you know, Facebook and some
Speaker 1: of the big tech companies, Um Lawrence. You mentioned um
Speaker 1: Peter Lynch, and you know, you have this idea of like,
Speaker 1: okay companies, you know is sort of a thing that
Speaker 1: we associate with Peter Lynch. But what are the things
Speaker 1: that would you would look forward to say, okay, this
Speaker 1: has economics that might over a long time be similar
Speaker 1: to what we saw in tobacco. I would say, just
Speaker 1: first of all, on the on the alcohol industry question,
Speaker 1: it is interesting and my understanding is they sort of
Speaker 1: went the opposite way of tobacco with Jimmy Carter deregulating
Speaker 1: the beer industry in the seventies, it became very fragmented.
Speaker 1: You had the rise of a lot of craft brewers,
Speaker 1: some of the big breweries started to lose market share
Speaker 1: and pricing power and so forth. One other interesting dynamic
Speaker 1: I think you've seen play out in this pandemic or
Speaker 1: that hasn't helped the shares at all, is because of
Speaker 1: the restrictions on public smoking, there's not a lot of
Speaker 1: waste that goes into it, whereas you're seeing a drop
Speaker 1: and an alcohol consumption because of the loss of public
Speaker 1: venues at sporting events and concerts and so forth. So
Speaker 1: in a way, there's there's just not a lot of
Speaker 1: waste in the in the tobacco industry from the production standpoint.
Speaker 1: I think there's a lot of different reasons why tobacco
Speaker 1: is unique and alcohol is as sort of uh not
Speaker 1: deliver the same returns. I think they have been okay,
Speaker 1: but but just not as great. And it's just from
Speaker 1: unique dynamics there. When you look at the other sin
Speaker 1: stock industries, um, you know, we compare it to casinos,
Speaker 1: defense names, alcohol and so forth. And I think we
Speaker 1: have this idea that that send stocks do well simply
Speaker 1: because nobody wants to own them. There's an interesting study
Speaker 1: by Robico which which shows that a lot of these
Speaker 1: so called sin industries do well because they're highly profitable.
Speaker 1: So they sell things that that people need and good
Speaker 1: times and bad. They are in a way recession resistant.
Speaker 1: They have a high degree of consistent cash flow, so
Speaker 1: they're not very cyclical at all. They tend to have
Speaker 1: clean balance sheets, so those are sort of proxies for
Speaker 1: what we call the quality and low volatility factors. And
Speaker 1: in a in a lot of ways, and this is
Speaker 1: especially true and tobacco, they very rarely get overvalued. And
Speaker 1: so if you compare that, for example, with Coca Cola
Speaker 1: and and and PEPSI. That's a similar industry in the
Speaker 1: terms of it being more or less a duopoly. Their
Speaker 1: products are more or less recession resistant, highly profitable, tremendous
Speaker 1: brand loyalty, and so forth, but at different periods of
Speaker 1: time they've become very expensive. In the case of Coca Cola,
Speaker 1: it's really been almost bubble like in two instances, the
Speaker 1: late nineties and the early seventies with the nifty fifty.
Speaker 1: That sort of froth has never really happened in tobacco.
Speaker 1: I think about the highest and multiple has ever got
Speaker 1: was the low twenties. I think gene can correct me
Speaker 1: on that. That's pretty high for a low growth industry,
Speaker 1: but it's not so high to the point where it's
Speaker 1: going to impair your returns over time. And so I
Speaker 1: think maybe defense is another indust try that has similar dynamics.
Speaker 1: The returns very rarely um fall out of line from
Speaker 1: a historical pattern. There doesn't seem to be a a
Speaker 1: lot of incidents of excessive valuation. You have the whole
Speaker 1: sort of E s G problem there, with a lot
Speaker 1: of people not willing to own weapons manufacturers and maybe
Speaker 1: that plays a part in keeping valuations under wraps. But again,
Speaker 1: it's a very oligopolistic industry with a lot of consolidation,
Speaker 1: a few major players, very high barriers to entry. Um.
Speaker 1: There's not a lot of those industries around, but but
Speaker 1: there are a few. And I think that's kind of
Speaker 1: what I look for in the in the industry is saying,
Speaker 1: is this a place where, uh, it's it's going to
Speaker 1: be a good place to do business and and look
Speaker 1: at those kind of big picture dynamics and then sort
Speaker 1: of go down from there and and see what are
Speaker 1: the best opportunities for those various players in this industry
Speaker 1: that I know is going to be around for a while. Well, Uh,
Speaker 1: Gene and Lawrence, thank you so much. So I guess
Speaker 1: the lesson is sell addictive sin products and have an oligopoly,
Speaker 1: is it? Is it good? Uh? Is? This is this secret?
Speaker 1: Plus a lot of government regulations and other things that
Speaker 1: make it hard to compete is the secret? But now
Speaker 1: that was fantastic, And really appreciate both of you coming on.
Speaker 1: Thank you for the opportunity. It's a pleasure to be
Speaker 1: with you folks. Thanks for having me. Thank you so much. Uh,
Speaker 1: Tracy I love talking to anyone that just like knows
Speaker 1: a specific industry that well, I mean, both of them
Speaker 1: super interesting. But hearing gene sort of like history of
Speaker 1: how the industry came to be what it is. I
Speaker 1: loved hearing all it. Yeah, absolutely, And it's probably not
Speaker 1: surprising that selling an addictive product can be a real
Speaker 1: money maker over time. I think everyone knows that at
Speaker 1: this point. But just watching how the industry evolved, and
Speaker 1: also seeing how government regulation that was actually supposed to
Speaker 1: clamp down on cigarettes in many ways concentrated power in
Speaker 1: the existing tobacco companies. I thought that was really interesting.
Speaker 1: And also the dynamic between Philip more Morris and R. J.
Speaker 1: Are how one of them was basically very successful and
Speaker 1: the other one kind of foundered, foundered just because um,
Speaker 1: well of different strategies, you still had an oligopoly, but
Speaker 1: vastly different outcomes. That was really interesting just hearing like
Speaker 1: all of the different things that sort of like set
Speaker 1: this industry on its way to being a sort of
Speaker 1: a unique asset class. From an investor perspective, I still
Speaker 1: thought that was really interesting. I love genes analogy about
Speaker 1: like Okay, you're sitting on an oil well, you know,
Speaker 1: the oil well has almost only so much life in it, right,
Speaker 1: Like there is a finite amount of oil, and maybe
Speaker 1: there is a finite amount of people who will ever
Speaker 1: smoke cigarettes. And so the question is do you take
Speaker 1: that cash and try to find the next oil or
Speaker 1: the next cigarette, or do you just you know, keep
Speaker 1: disciplined with that cash, don't try to find the new thing,
Speaker 1: reinvest in the business and give a lot of money
Speaker 1: back to shareholders, and the sort of the divergent paths,
Speaker 1: and in the end, sounds like the companies that just
Speaker 1: sort of stuck to their knitting and bet on tobacco
Speaker 1: as opposed to trying to find the next big thing,
Speaker 1: we're the ones that went out. Yeah, I mean another
Speaker 1: one of the surprises in that conversation was that R
Speaker 1: j R. Was the company that diversified, which is what
Speaker 1: you're traditionally supposed to do when you have a product
Speaker 1: that's falling out of favor, and they did a lot
Speaker 1: worse than Philip Morris. You know what I was kind
Speaker 1: of thinking during that oil analogy, maybe the tobacco company
Speaker 1: should set up like a sovereign wealth fund right with
Speaker 1: their capital if they're just trust Yeah, yeah, they might
Speaker 1: as well write if they're going to give up on
Speaker 1: tobacco products eventually. I mean, I guess, you know, I
Speaker 1: don't know. It'd be interesting to hear to get into
Speaker 1: a further conversation about the the sort of master settlement agreement,
Speaker 1: because I kind of feel like there might be an
Speaker 1: analogy there between state sovereign wealth funds in oil rich
Speaker 1: countries and the funds that various well literal u s
Speaker 1: states have set up with that sort of recurring royalty
Speaker 1: stream from that settlement agreement from tobacco companies. There's probably
Speaker 1: there's probably actually a lot to uh draw there in
Speaker 1: terms of comparisons, and then how that cash would you
Speaker 1: use and how that cash is sort of funneled to
Speaker 1: public authorities. Yeah, I think you're right. Well, I guess
Speaker 1: we have another idea for an episode then up one day.
Speaker 1: All right, shall we leave it there? Let's leave it there,
Speaker 1: all right. This has been another episode of the All
Speaker 1: Thoughts podcast. I'm Tracy Halloway. You can follow me on
Speaker 1: Twitter at Tracy Halloway and I'm Joe wi isn't Thal.
Speaker 1: You can follow me on Twitter at the Stalwart and
Speaker 1: follow our guests on Twitter Lawrence Hampton, He's at el Hampton.
Speaker 1: I don't think Gene is on Twitter, but you can
Speaker 1: check out his book Going Down Tobacco Road. R J.
Speaker 1: Reynolds Tobacco Empire at The gold Leaf and North Carolina,
Speaker 1: and be sure to follow our producer Laura Carlton. She's
Speaker 1: at Laura M. Carlton. Followed the Bloomberg head of podcast,
Speaker 1: Francesca Levi at Francesca Today and check out all of
Speaker 1: our podcasts under the handle at podcast. Thanks for listening
Speaker 1: to