A.G. Barr (BAG) Stock Purchase – Are Drinks The New Tobacco? 1

Over the course of history, tobacco stocks have outperformed all others. British American Tobacco, Imperial Tobacco, Phillip Morris (Altria) and Reynolds America have all consistently produced double digit returns over the past 40 years. $10,000 invested in Altria (MO) over 40 years ago would be worth $2,191,990.07 today. Yes, that’s over $2million for a return of 21,819.90%. This is simply phenomenal and far greater than market returns. One of the big returns for Tobacco’s outperformance over the long-term has been regulation.

Why the Sugar tax won’t hurt investors and profits

To say the tobacco industry has gone through the mill in terms of regulation over the past few decades is a massive understatement. The industry has had to deal with bans on advertising, massive taxation hikes, non-smoking zones and an enormous public health drive against cigarettes and smoking. They’ve also had to deal with the increased popularity of vaping and the Pockex Vape Pen, in particular, that has no doubt had an effect on the industry and the amount of money that they are generating as a result. With all these headwinds surrounding the industry one must assume that investor profits from tobacco companies would dwindle over time. Yet, the opposite has happened. The tobacco companies have consistently generated high free cash flows over this period thus giving investor supernormal returns.

In hindsight, regulation has in fact been good for tobacco stocks. I have explained why this is so before in my post titled ‘ Investing in the tobacco industry – why regulation will not curb the great investor returns‘. So have a read of that article to understand why this is so. But in short, regulation drove down competition in the tobacco industry. Thus the supply level is ‘rigged’ in favour of the incumbent companies and we all know that demand will always be there as the product is addictive, and thanks to the many advancements in tobacco and how it can be consumed, whether that be by vapes or with these Kapten snus products, its now more popular than ever before. As economics 101 teaches us, high demand plus high price plus no new competition means that the standard mean reversion principle does not exist. Instead, firms within the industry are able to make super sized profits over long periods.

With the introduction of the sugar levy, it seems that the carbonated soft drinks industry is going much the same way tobacco went over the past few decades. There is currently a real fear that the punitive sugar tax is only a start and more regulation will be brought in over time. As more regulation comes in, new entrants will be deterred from entering the market and this means that the current incumbents like A.G Barr, Britvic, Coca Cola and Nichols will only strengthen their positions in the UK sugary drinks industry.

In short, if the tobacco industry is any guide as to what happens when governments meddle and bring in regulation, I say bring it on!

AG Barr Analysis

The recent de-rating of A.G. Barr stock represents a buying opportunity in one of the high quality company’s in my master list of stocks. It appears that the market is worried over the government’s proposed soft drinks sugar tax, that is now in the consultation phase. But as mentioned, I don’t think the sugar tax will be as bad on the incumbents as the market is making it out to be. The company is already accounting for this by recently launching IRN-BRU XTRA and Rubicon Spring, both containing no added sugar, and ‘are both performing well at this early stage’ according to the CEO.

The interim results released on 27 September reflected deflationary, promotional market conditions and poor early summer weather. Even though total sales weakened to £125.6m (2015: £130.3m) and like-for-like sales fell 2.8%, pretax profit edged up to £17m (2015: £16.9m). This is why I love companies with high operating margins. Even if sales reduce, profits can still be far higher. In addition, the interim results pointed out that return on capital employed (ROCE) grew 110 basis points to 20%, underscoring management’s shareholder value creation credentials.

Furthermore, interim free cash flows of £19.6m helped reduce net debt to £6.6m to give a lowly net debt/EBITDA ratio of 0.3 times. This bullet-proof balance sheet gives A.G. Barr the dry powder to invest in its asset base, brands and new product development as well as further acquisitions.

My A.G. Barr (BAG) Stock Purchase

The recent share price weakness has left AG Barr trading on 15 times forward earnings, which is cheap relative to the historical average. The dividend yield is close to 3% and that is amazing for a company that has a result business model and has grown its dividend for 16 years straight.

I bought 207 shares at a price of 480p each. I have bought AG Barr shares before through my monthly stock purchase programme. In total, I now own 321 BAG shares which pay me a dividend of £43 a year.

When looking to build a dividend growth portfolio, you need to buy into dividend paying stocks that have shown both reliability and longevity. The longer a company has paid dividends without cutting it, the better. For a quick measure of this, find out what the stock did in 2008. If the company continued to pay its dividend throughout the 2008 financial crisis, then that is a stock that has a strong balance sheet and could potentially survive anything.

With 16 straight years over dividend increases, AG Barr is a company that definitely passes the dividend growth test. The rate at which those dividends have increased has also been exceptional with an 8% increase per annum over the past 5 years. I suspect that the dividend increases will continue in the future as the dividend payout ratio is a lowly 50%.

As mentioned in a previous post on BP, my favourite holding period is forever. Short-term investing can be educational and at times quite lucrative but it is also extremely stressful and time consuming. You are far better off as a long-term investor. By being a long-term investor, you would have more money and a larger stream of passive income five years down the line. Long-term investing is by far the easier route, albeit the more boring, but it is also far more lucrative for the patient than a short term trading strategy.