World’s biggest tobacco seller plans IPO spin-off
China National Tobacco, the world’s largest tobacco company, may list its international unit in an IPO in Hong Kong later this year. This unit, China Tobacco International (HK), is primarily responsible for purchasing tobacco leaves from countries like Brazil and Canada for its state-owned parent company.
China Tobacco International is only a small part of China National Tobacco’s business, but an IPO would give investors a rare opportunity to own part of the state monopoly, which holds 40% of the global cigarette market. British American Tobacco (NYSE: BTI) and Philip Morris International (NYSE: PM), the world’s two largest publicly traded tobacco companies, both hold global market shares in their mid-teens and only sell their products in China through joint ventures with China National Tobacco.
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Could China Tobacco International be a better investment than BAT or PMI when it goes public? Let’s take a closer look.
What we know about China Tobacco International
Pre-registration documents indicate that China Tobacco International’s revenue fell 21% per year to HK $ 5.1 billion ($ 651 million) in the first nine months of 2018. This drop seems dismal by compared to the growth rates of PMI and BAT.
Philip Morris International revenue grew 8% to $ 22.1 billion first nine months 2018, and non-GAAP revenues from British American Tobacco (which include Reynolds American sales in both periods) fell 6% to 11.53 billion pounds ($ 14.5 billion) in the first half of 2018.
However, unlike these companies, China Tobacco International is not a direct retailer of cigarettes. It mainly generates its revenue from a fixed mark-up of 6% on its sales of imported tobacco leaves to Chinese cigarette manufacturers.
It generates a smaller percentage of its income by selling the cigarettes exported from China, which are mainly sold in duty-free stores to Chinese tourists. The unit retains full control over cigarette exports from China. Last May, the company started exporting Chinese-made heated tobacco devices similar to PMI’s IQOS, but these are unlikely to generate significant revenue yet.
China Tobacco International reported a gross margin of 5.8% in the first nine months of 2018, up from 6.5% a year earlier, but did not disclose its operating margin, which is expected to be slightly lower. For comparison, PMI published an adjusted operating margin of 39.2% for the same period and BAT published an operating margin of 38.1% in the first half of 2018.
China Tobacco International’s pre-tax profit fell 23% annually to HK $ 358.3 million ($ 45.7 million) in the nine-month period, and its reported profit also fell 23% at HK $ 222.3 million ($ 28.4 million) – giving it a net profit margin of 4.4%, up from 4.5% a year earlier.
This is not a traditional tobacco game
Simply put, investors should not confuse China Tobacco International with its parent company, nor with traditional cigarette makers like PMI or BAT. In 2012, a rare snapshot of the finances of China National Tobacco revealed that the state monopoly was generating an annual profit greater than Walmart.
Unfortunately, China Tobacco International’s upcoming IPO will not give investors a significant share of those profits. Instead, the unit appears to simply be leveraging its parent company’s reputation to raise funds. This should be a bright red flag for investors. This IPO will look nothing like AltriaPMI’s spin-off over a decade ago – a move that completely divided its domestic and foreign operations.
China Tobacco International would be an attractive investment opportunity if it brought part of its parent company’s cigarette sales to China, or if the company were to expand beyond its core business of importing tobacco leaves for domestic use. Chinese cigarette manufacturers. But as it stands, the company appears to be a weaker investment than PMI or BAT, and it may struggle to attract investors in today’s tough Chinese equity market.
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