November 1, 2018

Is Your Fund Tobacco-Free Yet?

“With 7 million deaths worldwide each year and a forecast of one billion deaths this century due to tobacco-related illnesses, global and multi-stakeholder collaboration is needed to tackle the devastating impact of tobacco on society, as well as on the environment. Addressing the financing of tobacco companies – across lending, insurance, and investment - is an essential component of this collaboration.”

From the Tobacco-Free Finance PledgeSigned by 95 financial institutions from 16 countriesOn 26 September, 2018 at UN General Assembly, NYC


The Tobacco Investment Question Revisited

The title of the October 2017 Letter was “Why Your Fund Should Be Tobacco-Free”. It offered two mutually-supporting reasons for this assertion:

  1. There are ethical and reputational risk reasons for not owning tobacco stocks. Doing so endorses a product that is the #1 cause of preventable deaths in the world, and that has been globally blacklisted through the UN Tobacco Treaty. Of the UN’s 17 Sustainable Development Goals, 13 are negatively impacted by tobacco consumption. Tobacco companies employ child labour, often under unacceptable working conditions. At the same time, these children are primary targets for the product (e.g., 1 in 5 Indonesian children under the age of 10 are smokers).
  2. There are also financial risk reasons for not owning tobacco stocks. On the demand side, the UN Tobacco Treaty represents a growing degree of international cooperation to reduce smoking (e.g., through excise taxes, packaging restrictions, nicotine regulation, etc.). On the supply side, the cost of production is rising through aggressive legal actions to compensate individuals and health systems for the suffering and medical costs of treating victims for  smoking-related illnesses. Taken together, these demand and supply developments will increasingly squeeze the tobacco industry’s profit margins and create ‘stranded asset’ risk down the road.

These were the two bases for my ‘why your fund should be tobacco-free’ stance last year. So one year later, why this follow-on Letter? What has happened? Three things: 1. As noted above, representatives of many of the 95 Founding Signatories of the Tobacco-Free Finance Pledge from 16 countries gathered at the UN on September 26 to formally commit their organization to not providing insurance to, lending money to, or investing in tobacco companies, 2. Tobacco stock prices are materially lower than they were a year ago, and 3. A new academic study shows that even at today’s lower share prices, a material risk of further price declines remains.

Materially Lower Share Prices

Last year’s Letter noted that historically, tobacco stocks have been strong performers. For example, over the 2005-2015 period, the MSCI World Tobacco Index was up 195% versus 90% for the Information Industry Index and 50% for the World Index. The Letter noted that many analysts continued to recommend investment in tobacco stocks despite steadily falling sales volumes. ‘Buy’ ratings were based on such considerations as generous dividend yields in the 3-6% range, a steady diet of share buy-backs, and (so far at least) the industry’s ability to raise prices enough to offset falling sales volumes. 

In fact, tobacco stocks have performed poorly this year, with the ‘top six’ suffering an average price drop of some 20% in a flat stock market. So what happened? Could it be that the tide has begun to turn against tobacco stocks? A just-released academic study titled “The Future of Tobacco Stocks: A Scenario Analysis” sheds material new light on this question.

The Future of the Tobacco Industry

The Study was commissioned by Tobacco Free Portfolios (TFP), founder of the global Tobacco-Free Finance Pledge cited above.i It was performed by faculty members and students of Maastricht University’s School of Business and Economics, with assistance from Cardano Risk Management, as well as from TFP’s Advisory Working Group.ii The Study’s purpose was to provide an objective assessment of the financial risks embedded in tobacco stocks, and whether their late 2017 prices duly reflected those risks.

The resulting Study has three parts: 1. Industry Background, 2. Three Future Industry Scenarios and Consequences, and 3. Investment Implications:  

  1. Industry Background: investors have experienced strong historical returns due to the addictive nature of the product, and to market expansion in the globe’s developing economies. The industry currently sells some 5.5T cigarettes per year, with the top five firms generating $125B/yr. in revenues. The industry has been largely successful in deflecting criticism related to the negative addiction, health, and environmental implications of using its product, to its deceptive communication practices, and to its continued use of child labour. However, some headwinds have begun to appear in the forms of increasing regulation, taxation, litigation, boycotts, and divestment by institutional investors. These headwinds are slowing revenue growth and increasing the costs of operation.
  2. Three Scenarios for the Future: the STATUS QUO scenario (called PAST PERCEPTIONS in the Study) assumes the industry will be able to navigate its way through these emerging headwinds. The move to vaping and to the legalization of marijuana will help offset declines in the demand for cigarettes. Clever legal strategies successfully control the apparently growing threats of class action suits for recovery of medical costs related to treatments of smoke-related illnesses. The industry’s reputation is improved by a steady move away from using  children to harvest tobacco leaves. In contrast, in the SMOKE scenario the headwinds continue in the form of continued international              co-operation towards stronger anti-tobacco legislation and regulation. This includes the developing economies as the health and environmental costs of smoking become better understood. Class action lawsuits are meeting with increasing success, as negative media coverage on child labour practices strengthens. Things get even worse in the FIRE scenario with even stronger anti-tobacco legislation and regulation (e.g., severe nicotine content restrictions) around the world. This, combined with further tax increases, leads to further material declines in smoking. On the cost side, litigation-related payments to plaintiffs begin to rise. Through all this, the reputational risk to tobacco investors becomes increasingly visible, leading to a rising cost of capital for the industry. Longer term, as non-smoking parents raise non-smoking children, the incidence of cigarette smoking continues to fall.
  3. Investment Implications: the Study makes tobacco industry revenue and cost growth, as well as valuation projections using a Discounted Cash-Flow (DCF) model for each of the three scenarios. It applies these projections to four specific tobacco stocks: British American Tobacco (BAT), Imperial Brands (IB), Philip Morris (PM), and Japan Tobacco (JT). The key question is: how do the three scenario/DCF hypothetical prices for each of the four stocks compare to the actual four stock market prices on two dates: December 31, 2017 (i.e., when the Study was done) and November 13, 2018 (i.e., when this Letter was written)?

Table 1 below answers that question.

Are Today’s Tobacco Stock Prices Cheap, Expensive, or Just Right?

The Study posits a series of plausible scenario-specific inputs into the DCF valuation model for three periods: 2018-2022, 2023-2033, and from 2034 onward. These include projections for future revenues, costs, profit margins, and cost capital. With these inputs, the hypothetical ‘right’ value for each of the four tobacco company stock prices can be calculated. They are displayed in Table 1, along with the actual stock prices on December 31, 2017 (i.e., at the time the study was conducted), and on November 2018 (i.e., when this Letter was written). Note that Table 1 confirms the material declines in tobacco stock  prices this year during a period when the broad market indexes were essentially flat. Table 1 also allows us to compare the actual Dec 31 and Nov 13 prices to the three scenario-based hypothetical ‘right’ prices:

  • BAT had an optimistic STATUS QUO price at the start of the year, but is now priced for a world somewhere between SMOKE and FIRE.
  • PM also had a relatively optimistic price at the start of the year, but is now priced for SMOKE.
  • IB was already priced for a world somewhere between SMOKE and FIRE at the start of the year, but its price now reflects something closer to a FIRE world.
  • JT was already priced for a FIRE world at the start of the year, but is even more so now.

In short, it seems that ‘the market’ has caught up with some of the risks set out in our October 2017 Letter titled “Why Your Fund Should Be Tobacco-Free”, and further quantified in the Maastricht University study. Prices now reflect an industry future somewhere between SMOKE and FIRE. In concluding, the Study noted that the FIRE scenario does not necessarily represent the worst case outcome. For example, it does not embody a   cascading series of adverse ’medical cost recovery’ judgements resulting from the litigation actions currently working their way through the courts. Such events could lead to stock prices well below those calculated for the FIRE scenario.    

Table 1    Scenario-Based Hypothetical and Actual Tobacco Stock Prices

  STATUS QUO SMOKE FIRE Dec 31 2017 Nov 13 2018 % Change
BAT £51 £35 £21 £50 £28 -44%
IB £93 £49 £21 £32 £26 -19%
PM $125 $89 $57 $106 $88 -17%
JT ¥8000 ¥5300 ¥3200 ¥3600 ¥2800 -20%
SP500       2696 2722 1%
MSCI WORLD       2110 2029 -4%

Sources: “The Future of Tobacco Stocks: A Scenario Analysis”, Maastricht University, S&P, MSCI

Where to from Here?

So where to from here? New Zealand Super explained its 2007 ‘tobacco-free portfolio’ decision this way:

  • As a product, tobacco fails product safety and ethics tests.
  • The tobacco industry is a poor prospect for effective investor engagement.
  • Tobacco investment has no material impact on the Fund’s reward/risk characteristics.
  • Investment would be inconsistent with the UN Tobacco Treaty - the WHO Framework Convention on Tobacco Control. Thus investing in tobacco would damage New Zealand’s reputation in the world community as a responsible investor.

New Zealand Super notes that over time, its 2007 divestment decision has garnered broad support from its stakeholders.

If, like New Zealand Super, your organization is already one of the growing number of Signatories to the Tobacco-Free Finance Pledge, take a moment to celebrate the progressive decision already taken. If, on the other hand, your organization is not yet ‘tobacco-free’, take a moment to ask ‘why not?’ Possibly, it is because no-one to date has placed the ‘tobacco-free’ action item on the organizational decision agenda. After all, the manufacture and sale of cigarettes is not illegal, and investment returns have historically been good. Further, making investment decisions with ethical connotations often requires breaking new ground.

If you are not yet ‘tobacco-free’, I hope that this second tobacco Letter will place the topic on your organization’s decision agenda soon. The Maastricht University study shows that this year’s price declines may not yet be sufficient to cover the rising risks facing the tobacco industry. 

Keith Ambachtsheer



  1. Tobacco Free Portfolios is the only not-for-profit organization to promote ‘tobacco free’ finance and investing across the world. It does so by engaging key leaders and influencers across the global financial sector. Its strategy is to educate and advocate rather than to ‘name and shame’. I am a member of TFP’s Global Advisory Council. More information on TFP can be accessed HERE.
  2. The Maastricht Study was led by Prof. Rob Bauer, and carried out by a team of his second and third year students: Fabian Grohmann, Fabian Submann, Filip Dobrsynski, Jeroen Schmitz, Julian Alves, and Moritz Dillmann. Prof. Jeroen Derwall provided guidance in the use of the valuation tool provided by McKinsey&Co. Cardano Risk Management hosted a workshop on scenario thinking and analysis. The complete Study can be accessed HERE. Also, TFP commissioned its own report on the Maastricht Study findings. Written by Nathan Williams, it is titled Tobacco: Reviewing the Growing Financial Risks. It can be accessed HERE.


KPA Advisory Services is pleased to share this edition of The Ambachtsheer Letter with all readers; if you wish to become a KPA Advisory Client/gain access to ALL Letters, please see the Services page on our website.

The information herein has been obtained from sources which we believe to be reliable, but do not guarantee its accuracy or completeness. 

Advisory Service clients have access to full issues of the Ambachtsheer Letter.

Become an Advisory Service Client
or Login
Back to Top