OVERVIEW TOP NEWS FEED - Hinde Capital

OVERVIEW TOP NEWS FEED

OVERVIEW

OUR MAIN INVESTMENT IDEA 1. British American Tobacco plc

INVESTMENT INSIGHTS

WHAT HAPPENED? Market & Sector Analysis

HINDESIGHT DIVIDEND UK Portfolio # 1 (February 2019)

APPENDIX I: THE WAY WE THINK

APPENDIX II: HOW WE THINK

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Most readers will have been aware of my view of cryptocurrencies over the last few years. It is not

just the insanity of the ‘valuations’, the security of the ‘asset class’ has been at serious risk of appropriation and actual loss, as it is unregulated and unsupervised by the majority of global authorities. This headline, to me, sums up the entire industry at the current time. I’m sure that some of the amazing digital advancements the crypto world has developed will be incorporated into the recognised banking and payment world in the future, but ‘cryptos’ will be just a footnote in history by that time.

"BREWERY PISS-UP: CANCELLED DUE TO UNFORESEEN

CIRCUMSTANCES"

WWW.HINDESIGHTLETTERS.COMISSUE 51 - FEBRUARY 2019

2 HINDESIGHT Dividend UK Letter

We made a statement 18 months ago in the newsletter that we wouldn’t spend any time discussing Brexit or Trump in our writings. There is far too much wasted productivity by the politicians and civil servants already without anyone else doing so. As a Remainer voter on that fateful June day in 2016, I thought it was a straightforward choice.

But, I, like many others, was outvoted; well, not exactly. Only 37% of the country actually voted to leave, but with less than 75% voter participation, it was enough to get a majority vote that counted.

Two years on and no-one is covering themselves in glory, far from it. Where is Viscount Palmerston, that grandmaster of 19th-century foreign policy, when you need him? No doubt turning in his grave, several times over, watching the current

farce lurch to new lows every week on both sides of the channel. I did have to look up the salaries for MPs, raised last year to £77k, to see what appalling value the taxpayer is getting from them. The phrase, ‘Couldn’t organise a piss-up in a brewer’, roars into mind.

But, unlike some of the real lower value MPs, I would not whinge on about having a new referendum and expect a grand reversal of opinion. We have made our bed and the European bureaucrats have shown their colours. I, for one, would now be voting leave and hoping for a no-deal Brexit, just for the hell of it. Bring it on. Maybe, it will be really bad, maybe not, but let’s see. One of the troubles of the ‘negotiating ability’ (used in the loosest of terms) of the UK is to misunderstand that the issue of Brexit has always been a political issue for the Europeans, not an economic issue. Boris Johnson, who chose ‘Leave’ as the best chance to favour his own political career (how’s that working so far?), can spout on about Prosecco, BMWs and red wine, but the European bureaucrats don’t care.

Let’s look at the economies.THE COMPANY

Mark Mahaffey

Ben Davies

Aalok Sathe

HindeSight Publishing which runs HindeSight Letters is a unique blend of financial market professionals – investment managers, analysts and a financial editorial team of notable pedigree. The co-founders of Hinde Capital, Ben Davies and Mark Mahaffey, a successful alternative investment management company joined forces with the financial journalist David Stevenson best known for his regular columns in the FT Weekend, Money Week and numerous other global media titles to deliver something different in the financial newsletters segment – simply put it’s a reliable newsletter version of a managed fund.

Our writers actually run money, not just write about it, so they are the right mix of book smarts and street smarts. Truly a team of individuals that make up a formidable pool of knowledge, wherever the investing landscape shifts to.

CONTRIBUTORS

CO-FOUNDER & CFO OF HINDE CAPITAL

CO-FOUNDER & CEO OF HINDE CAPITAL

FUND MANAGER

• Did I think that extracting ourselves from a half-century ‘marriage’ of trading, legal and political entanglements was going to be easy? No.

• Did I think that the choice of being ‘administered’ by a bunch of self-serving bureaucrats in Westminister was any better than a bunch of self-serving bureaucrats in Brussels? No.

• Did I think that substituting European immigration to the UK, with the rest of the world immigration was a desired outcome? No

• Did I think that the UK, with its own currency, unrestrained by the Euro, running a twin budget and trade deficit, had the best of all worlds by being in the EU? Yes.

• Did I think that economically there was any chance that the UK was going to better off, in the short, medium or long term by leaving the EU? Was it going to be worth it? Not a chance.

ISSUE 51 - FEBRUARY 2019 3

Despite the UK still enjoying a record low unemployment rate, growth is clearly on the wane. Is it Brexit related? Maybe. For sure, it isn’t helping. Headlines of factory closures by Nissan and Honda may well be more specific to the changing dynamics of the car industry but Brexit may well be the tipping point or just a good excuse. It might be natural to assume that if it’s bad for the UK, it’s good for Europe, but that clearly isn’t the case, currently. The European economies look like they are heading back into recession, even with zero and negative interest rates and bond purchases by the Central Bank still ongoing. Five years ago, the Greek debt markets blew up in the aftermath of the 2008 financial crisis as debt to GDP levels soared to 180% and Greece became the first developed country to miss an IMF payment deadline. As the European Central Bank pulled out every stop in its armoury, the system peered into the abyss.

Today, the Italian bond market is rearing its ugly head. The size of the outstanding debt pile dwarfs Greece’s. Italian growth is continually weak and current politics are the most fluid of the EU block. We may have fracturing political parties in the UK, while France despairs at the yellow vests movement, but these pale in comparison to the situation in Italy.

Ultimately, we must face up to the reality that the EU and the euro are unlikely to survive another recession or government debt crisis and the grand 20-year experiment will come to its natural conclusion. Whether the UK Brexit vote of 2016 will be seen as the starting point catalyst for future historians or not is unknown but by then, we will

not be bickering about Irish backstops and hard borders, for sure. By then, we will probably be back to hard borders between every European country. Free movement of people and trade will be resigned to history for the time being.


OOur original thesis was developed as the tobacco giant’s share price had slumped due to:

• A downturn in demand for tobacco products due to public smoking bans and tax increases.

• China starting to change on a social basis, following Western countries by banning the use of cigarettes in public areas, such as restaurants, offices and public transport

• The negative outlook on the tobacco industry as governments intensify pressure due to the impact on individuals’ health.

British American Tobacco quickly extinguished fears surrounding the sustainability of its business by complying with several rulings and revealing its strategy to expand into the electronic cigarette industry. The analyst community became convinced that the firm was extremely undervalued given its diversified revenues and superior product offers. This saw BATS’ share price surge over the next two years, eventually reaching its high in Q2 2017. Since then, it has once again fallen into a torrid negative trend, which has seen it fall over 58% from its high. The company has become one of the biggest dogs across all the large-cap FTSE350 stocks.

Over the years, BATS has built an impressive portfolio of products that have met the needs of its client base across the world. Unfortunately, the company has come under pressure as there are fears over its earnings potential going forward due to global pricing pressure, the government clampdown on tobacco-related products, uncertainty

surrounding the vaping industry and a general feeling that the global markets are not healthy.

Since we last recommended BATS, the company has gone through some serious highs and lows, with its current situation being an extreme low. The exhaustion that we are seeing has been flagged by our proprietary trend indicator (shown below).

By Aalok Sathe

Our current Buy Recommendation for British American Tobacco plc (BATS: LSE) was generated on 29th of January 2019 at 2450p. We originally recommended British American Tobacco plc in June 2015 at a price of 3511p when the FTSE100 was trading at 6726.57. We took profit in April 2016 during which time the advertising giant had risen 22.67% and 32.11% in absolute and relative terms respectively.

FUND MANAGER AT HINDE CAPITAL

INVESTMENT IDEA #1BRITISH AMERICAN TOBACCO PLC


Coinciding with the exhaustion patterns that we have been observing, this stock is also trading at the lowest levels that we have seen since 2008/2009 on a long-term RSI basis, demonstrating how extreme the current lows really are. BATS is hugging the bottom of its trading range and, having triggered signals on our 18-month RSI indicator, we believe

this is significant as it is a rare observation. Clearly, with the company trading at such low levels and offering a forward P/E of 9.86, it is evident that a lot of the negativity is now priced into the firm’s value. How much worse can it get?

Despite all the negativity surrounding the firm, it has maintained its earnings and free cash flow generation.

Just to summarise, the firm’s share price has come under attack due to: -

• Regulatory changes within the United States• Uncertainty surrounding the vaping industry• Lingering worries over the global economy

Regulatory Changes – Nothing New

The biggest threat to the tobacco company’s share price has come from a potential crackdown in the United States. Menthol cigarettes account for approximately 36% of the market in that region and BATS made a significant acquisition last year by buying Reynolds American, the leader in this market. Its share price has slid quickly with many analysts slashing their forecasts and outlook for this global giant. Despite all the negativity, it is very clear now that any change in the United States will not come anytime soon. This gives the company significant time to prepare and lobby to reduce the impact on its business. The industry has constantly lived under the pressure of regulatory changes and, in our opinion, is well versed in making its case to the governing bodies in order to protect its interests. Therefore, this new threat is not the biggest it has faced in its existence and the firm will recover, delivering value to shareholders going into the future.

Vaping Volatility

The management team at BATS has been putting a significant proportion of its hopes on the e-cigarette industry through the vapour business and tobacco heating products. In the past six months, this part of the business has come under attack from the US Food & Drug Administration, whose commissioner warned that youth vaping levels had reached an all-time high and suggested that he would do everything in his power to stop a new


generation from becoming addicted to nicotine. Despite all this uncertainty, nothing has materialised and even if there are new restrictions, BATS will be prepared for these changes and have gone as far to say that they will work with regulators to achieve a satisfactory outcome.

Cheap Valuations

BATS’ market valuation has fallen significantly over the past 24 months. Aside from 2008, BATS’ valuation is now at one of its lowest ever levels. With all the negativity priced into the stock’s valuations, this is an unusual opportunity to invest in a leading global company that generates significant free cash flow and one that we are expecting to go through significant changes. Relative to the index, it is trading at its lowest level in 12 years and was one of the highest-ranked opportunities within our quantitative model (below), making it one of the dogs of the FTSE350. With all the bad news priced in, BATS created a rare but powerful Doji pattern on 28th January 2019 (below) which, combined with our own proprietary signals, led to our recommendation.

Cheapest Stock in the Cheapest Market

The investor world is petrified of where the global market is heading to. Even when you sense the smallest possibility of instability, market volatility rises quickly. Currently, the UK equity market is one of the cheapest around the globe. With significant bad news priced in as we lead up to the end of March (when the UK is expected to leave the EU). We believe that buying the cheapest stocks in the cheapest market, gives any investor the ability to compound long-term returns. With that said, BATS is one of the cheapest constituents within the FTSE350 and we believe it will help any investor compound their wealth from current levels.

Analysts’ Corner

BATS is an industry moving giant within the branding and marketing industry. It has a global presence and is widely followed by the research community. The company is attributed with an average target price (TP) of 3735p, representing an upside of over 45%.

Summary

BATS is one of the largest tobacco producers in the world and is going through significant changes, trading at a significant discount and ultimately offering a rare investment opportunity. The company has been on the rocks over the past 24 months with regulatory threats and an evolving product line that has regularly been questioned. Many felt that this may leave the company in a terrible predicament; however, we believe this presents an inflection point and a serious shake-up within the company will help it to revert higher. Revenues and earnings will pick up, leaving the firm at a much higher level going forward. We expect the company to manage itself through all its potential threats just as it has done throughout its history, helping to deliver shareholder value. With BATS being one of the cheapest stocks in the UK market and this market being cheap relative to the globe, we believe a bright light will shine on this tobacco giant.


By Mark Mahaffey CO-FOUNDER & CFO OF HINDE CAPITAL

INVESTMENT IDEA #2

BRITISH AMERICAN TOBACCO PLC ‘DEFENSIVE SMOKER’

PREVIOUS WRITE-UP ON BATS FROM 2015 TRADE RECOMMENDATION (23% PROFIT)

Price (£)Turnover (£mm)Net Income (£mm)Market Cap (£mm)Fwd P/E RatioDividend Yield (%)Payout Ratio (%)Total Debt to Total Equity (%)FCF to Market Cap (%)ROIC (%)

3,511.013,971.03,115.065,022.32164.76%88.2210.8%420.7%

BRITISH AMERICAN TOBACCO PLC British American Tobacco (BATS: LSE) is one of the five largest tobacco companies in the world, headquartered in London. The firm has a presence in 180 countries and a market leading position in over 50. The company was formed in 1902 as a joint venture between Imperial Tobacco Company and the American Tobacco Company. The parent companies reached an original agreement not to trade in each other’s domestic territories. British American Tobacco began trading in countries as diverse as Canada, China, Germany, South Africa, New Zealand and Australia, yet never in the United Kingdom or the United States.

The history of cigarettes can be traced back to Mexico and Central America, where locals used what looked like smoking tubes in the 9th century. Later, the Mayans and Aztecs smoked tobacco in religious rituals, which were often depicted on pottery and temple engravings. Through Hispanic roots, the cigarette was brought back to Spain and eventually found its way into France, where it was officially named the cigarette in 1830. Over a decade later, the French state tobacco monopoly started manufacturing them in large batches. France’s cigarette production rose quickly in the 1880’s when James Albert Bonsack invented the cigarette-making machine. This helped production to rise from 40,000 hand rolled cigarettes to just below 4million on a daily basis.

In the UK, Sir Walter Raleigh is remembered for introducing tobacco after returning from his voyages fighting on the Spanish Main in the late 16th Century. He was the first British smoker, placing tobacco in a bowl and using a long pipe to smoke it.

British American Tobacco has a market capitalisation of £65bn and generates revenues well above £13bn. The company is also listed in the United States and South Africa. It has a strong presence in China and a long-term relationship through its factory in the Pudong district. As early as 1919, the Shanghai factory was producing over 240 million cigarettes per week, and the management team worked closely with the local Wing Tai Vo Tobacco Company to develop a successful cigarette brand called Ruby Queen.

Twenty years later, British American Tobacco was producing and distributing 55 billion cigarettes within China alone. However, the Japanese seized the firm’s assets following their invasion in 1937 and the company was ejected from China.

The group went through severe restructuring over several years before BATS was completely acquired by American Tobacco Group in 1994. This helped BATS to acquire the Lucky Strike and Pall Mall brands


into their portfolio. In 2003, BATS became the second largest producer and distributor of cigarettes in Italy, which is the second largest tobacco market in the European Union. The group has gone on to make further acquisitions in Eastern Europe, giving BATS the ability to manufacture its brands locally and saving costs on import duties. With Serbia, Bulgaria, Greece and Russia all in the list of the top ten cigarette consuming countries per capita, this proved to be a shrewd acquisition. The export opportunities have been significant as neighbouring countries have developed free trade agreements.

BATS have continued to grow and acquire businesses, targeting the emerging regions, such as Indonesia, Turkey and Colombia.

The group’s four most popular brands are Pall Mall, Lucky Strike, Dunhill and Kent. These are also complimented by Benson & Hedges and Rothmans.

Cigarette Industry

The cigarette industry has had a number of issues, ranging from legal battles to a decline in demand, due to public smoking bans and tax increases that have been introduced by most developed countries, even as far as the Philippines, Turkey and Brazil. Up until now, tobacco producers/manufacturers have relied on emerging market demand to negate a dramatic fall in demand for cigarettes within more socially developed European and North American regions. Emerging and frontier market demand will still continue to prop up tobacco producer volumes; however, in recent times it has been less effective. The most recent government intervention has come within China, which is the world’s biggest market. The Chinese government recently banned smoking in public areas, such as restaurants, offices and public transport. Given that the Chinese market is controlled by the China National Tobacco Corporation, this ruling does not affect British American Tobacco too much (even though they launched a joint venture with China National Tobacco Corporation) due to their low exposure. However, this latest ruling does demonstrate the current/future global trends.

Despite all these troubles, tobacco manufacturers have been very successful in managing these challenges over the past ten years. Nine years ago, BATS distributed 691bn cigarettes and the company was worth £29.6bn. Last year, the firm managed to sell 24bn less cigarettes and yet they were valued

at over £65bn. Tobacco groups have managed to increase their market valuation by using a three-pronged approach:

• Tobacco groups have continuously increased their prices. These manufacturers have managed to do this knowing that demand for cigarettes is inelastic, which means that consumers are willing to pay more for cigarettes, even if these prices are continuously raised. In many countries, the price of a packet of cigarettes is largely made up of taxes. Within the UK, nearly 80% of the price of a packet of cigarettes is paid to the government, so technically manufacturers are able to raise their prices by 5%, without pushing the total packet price up more than 1%.

• Tobacco groups are looking to counteract the decline in this industry through effective capital deployment, acquiring and merging with a variety of groups. BATS have been conducting a number of smaller bolt-on acquisitions, such as their recent purchase of TDR, which is a market leader in Croatia and the Balkan region. These deals provide a number of key cost-cutting opportunities and the chance to improve on an operational basis.

• Finally, tobacco manufacturers have been diversifying their offering and investing into the future. Two years ago, BATS introduced the UK’s first e-cigarette brand called Vype.

In the short-term, the tobacco industry has also been impacted by FX volatility. Pricing strength has gradually started to improve, whilst volume erosion, which has dogged tobacco manufacturers for the past five years, has started to increase. The industry has been hit by down-trading (shifting from premium to cheaper cigarettes), which many experts believe is linked to an increased uptake in plain packaging laws and believe this is a long-term risk to the tobacco industry.

British American Tobacco’s valuation is at the lower end of its historical range versus both itself and its closet rival, Imperial Tobacco. Despite the company’s resilient near-term earnings growth, the company has further room to grow, being positioned in certain frontier and emerging markets.


British American Tobacco currently has a HDVM® score of 53.46 and enters the HindeSight Dividend portfolio this month. An interim buy alert was sent to subscribers on June 17th 2015 at a price of 3511p. Over the last 12 months, the share price is flat relative to the index. This lack of performance can be attributed to:

• Decline In Consumption • Healthcare Lawsuits• Plain Packaging Regulations• Tobacco Tax Increase• Earnings Decline & FX Volatility

Demand for tobacco within Western Europe and North America may be declining, but this is not true on a global scale. Over the last five years, demand for cigarettes in Eastern Europe, large parts for Asia and South America has started to expand. British American Tobacco is now also looking at frontier markets, focusing on those regions where the middle class are becoming wealthier and have a higher disposal income.

The tobacco manufacturer over the last ten years (business cycle) has consistently provided investors with at least 3% in dividend income, weathering a variety of economic conditions.

Consumption, Positioning & FX Exposure

The tobacco industry has declined over the past few years, due to a small downturn in global cigarette consumption, with a particular focus on the European market, although according to Euromonitor, worldwide sales may increase 4.3% through 2019. Changes in consumption patterns are forcing the likes of BATS to be more creative in their quest to generate further revenue. They have been careful to acquire businesses as consumption within Western Europe declines as it matures. This refers to more affluent (developed) countries in which research has shown that smoking habits have fallen with increased awareness, education and wealth.

Global Cigarette Consumption from 1880-2014 (in billions of cigarettes) In the UK alone, the proportion of adults who smoke has fallen from 27.4% in 1999 to just above 18% at the end of last year. Similarly, adult consumption in North America has fallen from 24.1% to 17.4% over the same period of time. BATS are very much aware of this situation, as well as the social trends that are


impacting this industry on a global level. As a result, BATS have been investing heavily into the Eastern European market, where the smoking rate is the highest per capita (globally), which makes sound business sense. BATS started pushing into the Eastern European market as early as the fall of the communist regimes within this region; however, in recent years this push has intensified.

Similarly, BATS have also targeted Brazil with their attempts to buy out Souza Cruz, a prominent Brazilian cigarette producer. Both Eastern Europe and South America are emerging areas that offer plenty of opportunity for tobacco firms. They have some of the youngest and fastest growth populations. More importantly, with this growth we are seeing the emergence of a wealthier middle class with excess cash to spend, making these emerging areas more dynamic and favourable compared to more mature markets.

By increasing its exposure to emerging markets, BATS has added to its currency exposure, something that we have seen last year. Large fluctuations on the FX market, with a focus on the Rouble and other Eastern European currencies, have had a negative impact on BATS earnings. In 2014, BATS declared a 4% drop in earnings due to these major FX fluctuations. This drop in earnings has created temporary fear in the tobacco giant’s share price. However, with BATS strong track record for innovating and currency headwinds easing, this presents a good entry point into the British American Tobacco.

Along with easing FX headwinds, BATS is well positioned to benefit from reduced unemployment in Western Europe, whilst reaping the benefits of a

rising, wealthier middle class within the emerging markets, which will support future volumes.

Healthcare Lawsuits

Tobacco manufacturers have been hit by the justice system across a variety of countries in the last 12 months, having been asked to pay compensation to former smokers for “moral and punitive damages”. These damages were awarded on the grounds that tobacco manufacturers have been concealing the risks of smoking and its long-term effects. Although these lawsuits are the norm, the market has taken them negatively, fearing that these new rulings would trigger a wave of fines throughout the industry. Tobacco manufacturers value fell 2.4% when the ruling was announced, reducing their value by over £2.5bn from their market capitalisation.

Earlier this month, BATS Canadian subsidiary was ordered to pay £8.2bn in punitive damages to former smokers. These litigation cases are not new territory for BATS and neither is the magnitude of the amount awarded. Large amounts that are awarded in cases like this are often revised downwards during the

Source: statista


appeals process. Fortunately for BATS, the appeals processes tend to last over multiple years, and experts believe the magnitude of any pay out (which is usually revised down) would not have much of an impact on the intrinsic value of BATS’ business. Unfortunately, even though experts believe that damages such as these do not have a significant impact on BATS’ business, the market took this news particularly negatively, with the share price sold off further, having created an investment opening for long-term investors.

Tobacco Taxes (Excise)

Tobacco tax increases have created volatility within BATS share price, having instilled fear within the market place in relation to BATS ability to grow its earnings in the future, as governments increase their levies. Tobacco taxes have been raised steadily over recent years, as health departments believe this is potentially one of the most effective routes to tackling smoking. They believe that pricing individuals out of buying cigarettes and deterring children from developing a nicotine addiction in the first place is the best way to stem the issue. Within Europe, pressure is mounting on governments to introduce additional taxes on cigarette sales, which campaign groups believe will help to remove cigarette smoking within two decades.

Industry experts believe that government policies are likely to result in a continuing increase in tobacco tax across developed and some emerging markets. Health departments globally believe that raising the excise year on year will reduce the number of smokers and eventually extinguish the number of smokers completely. Continued tax increases have weighed down heavily on tobacco manufacturers globally and are now having a short-term negative impact on the market value on a global scale.

Unfortunately, academic research has shown that raising the price of a pack of cigarettes (after tax rises) tends to be ineffective on the general population, as it only really deters a small group of young adults and those from a low socioeconomic background. It often results in smokers merely downgrading to a cheaper brand. Within the UK and many other countries, nearly 80% of the price of a packet of cigarettes is paid to the government in the form of tax. The market reacts negatively to the news that tobacco taxes are going to be increased, but what investors do not seem to

understand is that BATS and other competitors have weathered these government attacks, as they are able to raise their prices by 5% without pushing the total packet price up more than 1%.

The tobacco industry is an oligopoly with a small number of producers and a large number of dependent (or addicted) consumers making demand for cigarettes inelastic and limiting the manufacturers’ downside.

Plain Packaging Regulation

Plain packaging (just like taxation and FX volatility) has fostered short-term negativity within the tobacco industry. Government departments believe it will act as a deterrent, just as they do with taxation. Unfortunately, research has shown that there are more prominent factors other than the packaging that influence a buyer’s behaviour. For example, a European Health Department report suggested that seeing your friends/colleagues smoke is more influential than the aesthetic of a cigarette box. Furthermore, reports on packaging conducted by Deloitte showed that neither increasing the size of health warnings on the packs, nor introducing images over a number of years had a direct impact on reducing tobacco consumption.

Unfortunately, tobacco producers believe that governments risk breaching trademark rights and international trade agreements by introducing the plain packaging law. Having created a very convoluted situation, various governments – from the Ukraine to Honduras and Indonesia – are all challenging these new laws at the World Trade Organisation.

Plain packaging regulations could become a hindrance for tobacco producers in the distant future. However, demand for cigarettes is once again propped up by consumers who are dependent on the product itself. Therefore, plain packaging will not prove to be the deterrent that many government bodies hope it to be.

Cost Savings & SAP Implementation

A large part of managing a mature company in a declining market is through creating an efficient company by using cost-savings measures. There is continued scope for margin improvement at British American Tobacco as it completes and leverages


upon its new SAP system. This new system will help BATS locate inefficiencies within its global structure and improve margins through cost saving measures. For example, experts believe that an improvement in cash flow could help the company to resume its buyback programme not too far down the line.

For companies, such as British American Tobacco, they have an inherent level of complexity, which can be easily managed as data is aligned across an organisation through a centralised system. Fifteen years ago, Nestle introduced a system called GLOBE, which enabled it to identify its inefficiencies. Six years later, the firm suggested that the GLOBE system had helped Nestle to save approximately CHF1bn annually. The company went on to introduce bolt on systems and standardise their data and processes. With all of the systems in place, Nestle are now saving more than CHF1.5bn annually.

With BATS hoping to complete the implementation of its SAP system by 2017, analysts believe this will eventually have the same impact on the tobacco giant as it did on Nestle. BATS will only see the full impact of this system and its benefits once the majority of its sales have been entered into the system, and then data analysts are able to suggest the best way to leverage the resources freed up as a result of this standardisation process.

The firm has been testing this system in Malaysia since 2011. Around half of BATS margin improvement over the last two years has come from cost savings derived from this system, demonstrating that when it is fully installed, it will have a greater impact on BATS margins, taking into account global savings.

Investing In The Future: E-Cigarettes

Initially, large tobacco manufacturers were slow to react to the emergence of the e-cigarette market. However, having recognised the uptake in demand for these products was a serious threat to the industry, tobacco producers have used their financial muscle to invest heavily in a market that is now said to be valued at greater than $3.5bn. Given that many of the large tobacco producers have their distribution networks set up, they will have a clear advantage over smaller players within the market. BATS launched VAPE, which was the first e-cigarette product to be launched in the UK and Western Europe, giving BATS first mover advantage. Since British American Tobacco’s launch, there has been a whole raft of

entrants into the Western Europe and North American markets.

The number of users in Western Europe has tripled over the past two years to 2.1million of which 700,000 users are ex-smokers. E-cigarettes may not replace the tobacco industry; however, it could well acquire a number of former smokers as users. This industry and its progress will be heavily dependent on regulation, taxation and product development.

Analysts’ Corner

British American Tobacco is a mature business, covered by a wide range of analysts. Over recent months, analysts have become more bullish on this business (with 21 out of 25 analysts giving it a buy or hold rating). Our scoring system suggests that the stock has an average 12-month target price (TP) of 3769p, representing an upside of 5% from recent prices.


Summary

British American Tobacco is trading at a discount to itself and its industry competitors, after suffering from a barrage of events that have weighed down heavily on its share price. BATS are in an oligopolistic industry serving an entire user base, which is dependent upon the product that they produce, giving it a reasonable margin of safety. This has created inelastic demand across the broader market, with certain pockets, such as the youth and low socioeconomic market, being deterred by the increase in prices due to taxation. The business has provided investors with a dividend yield of at least 3% over the last ten years, demonstrating its ability to provide income during the course of a full business cycle. With the stock suffering from negative price movements over the past year, this would be a good entry point into British American Tobacco.


INVESTMENT INSIGHTS

Successful investing over the long term, like most pursuits, requires a certain amount of time, dedication

and experience. Risks and rewards invariably go hand-in-hand and understanding those aspects will help the quest greatly. But history shows us there are indeed better and easier times to invest in different assets and, generally, across the whole spectrum. Unfortunately, current times are not ideal by any stretch of the imagination, and it is very important to keep this at the forefront of any investment thought process.

• Exceptionally high valuations across multi-asset classes

• Declining growth patterns across many continents

• Rising inflation, especially wage inflation

• Declining monetary liquidity

We remain at super-high valuations on equities by most metrics, with the US stock market defying gravity yet again. The muted decline reversed sharply last year when the Federal Reserve raised rates as they got frightened off by President Trump and levels are sky-high again. With interest rate and bond yields remaining negligible for income or capital gain, it is key to understand that severe downside risk prevails once again. GDP growth is falling across the globe, while wage inflation is gaining traction, adding to concerns. Any hope of liquidity maintaining support seems unlikely.


The chart below shows global monetary liquidity heading much lower, which historically correlates with large collapses in equity values.

Investing With a Crystal Ball

The legendary investor Jim Rogers used to say that you only had to make a decision on one asset class every ten years to enjoy unbelievably high investment returns and that diversification and over-trading were the way to min. The table below emphasises this.

Now this is of course with the benefit ofHind(e)sight, but one would have only needed to make 4 investment decisions over the last 40 years to make a mind-blowing return of over 175,000%. Undoubtedly the volatility and drawdowns of this strategy would have at times been unbearable, but it illustrates the point that all that is needed to make superior returns is to be in the right asset class at the right time (and make sure you're not in the wrong asset class at the wrong time). The better informed you are, and the more knowledge you have of valuation and economic conditions, the more you can then aspire to trade with the gods. For mere mortals, it still shows some diversification is certainly wise.

I wrote the above commentary in 2011, but clearly, if you switched out of gold back into US equities in 2010, you would have made another whopping 180% in your single asset class choice since then. I have brought this excerpt

out many times since its original writing for this newsletter to demonstrate the point. Of course, there have been other asset classes than equities or gold making stellar returns, but the decision-making process still relies on whether the asset class is cheap enough for a ten-year investment with no portfolio diversification.

If you had held gold from 1980 to 2000, instead of Japanese equities, you would have lost 70% of your money, with no yield either. Likewise, if you had held Japanese stocks from 1989 to 2000, you would have lost 75%.

I believe it is a far harder decision today, amidst the super-high valuations driven insanely by extraordinary money printing, to identify a major asset class that beckons a stellar ten-year return and could be considered cheap. Clearly, you should avoid being passively in the equity market at century high valuations or bonds at negligible yield if you want to hang on to your hard-earned wealth. But it seems so hard to accept that holding cash, which earns nothing, is an investment option.

What is cheap enough to own for ten years?

I will give you my two best bets for 2019-2029. One has the potential for yield and currency and capital appreciation, the other is a complete cycle re-rating.

• India bond markets• Gold/Silver mining stocks

We have written about the amazing opportunity for India in the quarterly India newsletter over the last few years. In our minds, the combined equity and bond markets offer the same amazing decade as the 1990s did for the US. My favourite chart is still the development of GDP across history.

Excerpt from 2011 HindeSight letter

1970-1979 100% invested in gold 1,363% return

1980-1989 Switched from gold to Japanese Equities

493% return

1990-1999 Switched from Japanese equities to US equities

317% return

2000-2010 Switched from US equities into gold again

391% return

1970-2010 Total compounded return of above strategy

177,530% return


Within five years, India will have the largest population in the world and, most importantly, a growing working age population – a very rare phenomenon with today’s demographics.

If you invest in India bonds, whether it is government, corporate or a hybrid, you are firstly doing that by investing in a ‘cheap’ currency; great for US investors, slightly less so for UK investors.

Secondly, you can receive and roll up a strong yield. Indian bonds yield across the spectrum range from 6.5%-13%. We all remember that if we compound at 7%, it takes 10 years to double your money.

I not only expect it will be possible to gain a 100% income roll up, but I also believe the currency will strengthen and the general level of bond yields will fall, as ‘emerging’ country inflation falls more in line with ‘developed’ country inflation. This will bring three potential sources of value: rolled-up income, capital appreciation with lower yields and currency appreciation when it is moved back to the host country in 2029. I don’t think I am sticking my neck out much here. Unfortunately, for most people, investing a large percentage of their wealth overseas will be the toughest decision of all. Understanding that very expensive home country equities are far riskier will be a hurdle.

Gold and silver mining stocks have become a forgotten market. Most of these stocks – junior and major caps – trade on the Canadian stock market with some other country listings. As an asset class, they are by far the cheapest. The metrics to measure them in 2011, at the

highs of the metals last bull cycle, are no longer used. They have, in all effect, become penny stocks, beckoning insolvency. Companies with no debt and hundreds of ground claims with in-situ metal values in the hundreds of millions are going for single digit market caps.

The indices, GDX mining and GDXJ junior mining have fallen by up to 80% in the last eight years and these are indices. Imagine how many actual companies have fallen the full 100% and closed! Canada is the land of bandwagons – boom and bust, pump and dump – in stock market practices, which have long since been outlawed by developed countries. Last year, all the brokers were raising money for crypto mining hardware. Recently, they have raised money for cannabis companies that now have ridiculous valuations and will no doubt overpromise and under deliver. At a conference in Canada, one analyst presentation showed that 82% of ALL Canadian public listed companies (not just mining) had negative net income! (That’s a loss to you and me.) But you get the picture. There has been no financing at all, to speak of, into smaller mining companies and the larger companies are failing to provide any real profit potential at these metal prices.

While I can clearly see the ‘cheapness’ of this asset class at the moment, in relation to the metal prices, and I believe the metal prices will have to rise as production falls off the proverbial cliff, there is a concern that the whole model is potentially broken.

As a result, I would not buy single stocks, only the indices. Often, when there is so much negativity and only extreme pessimism prevails, these are true cycle bottoms.


UK MARKET VALUATIONS

PORTFOLIO UPDATE - WHAT HAPPENED?MARKET & SECTOR ANALYSIS

UK INDICES PRICE/EARNINGS RATIO PRICE/BOOK RATIO DIVIDEND YIELD(%)

FTSE 100 INDEXFTSE 250 INDEX

15.3223.04

1.661.63

4.86%3.65%


HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (FEBRUARY 2019)PORTFOLIO UPDATE AND CONSTRUCTION

IMPERIAL BRANDS PLC On the 21st of February 2019, Imperial Brands plc paid a dividend of 65.46p.

PORT

FOLI

O

UPD

ATE


CURRENT EQUITY FACTOR MODEL

Highest ranked (‘cheapest’) stocks selected from the FTSE350 universe (as 28th of February 2019).

Name Ticker Model ScoreBRITISH AMERICAN TOBACCO PLC BATS LN EQUITY 61.33

VODAFONE GROUP PLC VOD LN EQUITY 59.61RESTAURANT GROUP PLC RTN LN EQUITY 59.33

WILLIAM HILL PLC WMH LN EQUITY 58.72HALFORDS GROUP PLC HFD LN EQUITY 58.24

CENTAMIN PLC CEY LN EQUITY 58.17PLAYTECH PLC PTEC LN EQUITY 57.81

WPP PLC WPP LN EQUITY 57.40PETROFAC LTD PFC LN EQUITY 56.92ELEMENTIS PLC ELM LN EQUITY 56.77

888 HOLDINGS PLC 888 LN EQUITY 56.65PZ CUSSONS PLC PZC LN EQUITY 56.33

HUNTING PLC HTG LN EQUITY 55.27BABCOCK INTL GROUP PLC BAB LN EQUITY 54.94

INCHCAPE PLC INCH LN EQUITY 54.53DS SMITH PLC SMDS LN EQUITY 54.39

JOHN WOOD GROUP PLC WG/ LN EQUITY 54.29SAINSBURY (J) PLC SBRY LN EQUITY 54.27

CENTRICA PLC CNA LN EQUITY 54.20BBA AVIATION PLC BBA LN EQUITY 53.95


We passionately believe that dividends really,really matter. William Thorndike in his fascinating book

'The Outsiders- Eight Unconventional CEOs and Their Radically RationalBlueprint for Success' examined one of the most impor tant aspects of running a business a CEO must undertake: Capital Allocation. He summarised how a CEO deploys capitalin order to best utilise cash flow generated from his or her business operations. Essentially,CEOs have 5 ways of deploying capital:

• Investing in existing operations• Acquiring other businesses• Repaying debt• Repurchasing their own stock (buybacks)• Paying dividends

Dividend payments are a crucial operation in creating stakeholder wealth. It is this aspect of a business that we are so fixated by - the propensity for a company to produce and continue to grow dividends so that we may accrue wealth over a generation. But as readers will know we can't just grab stocks with the highest yield for fear that this signals some cash flow or even solvency issues for the firm. So it is with this very real threat in mind we explore only well-capitalised FTSE 350 companies.

This letter's purpose is to help inform readers on dividend investing so that they can construct a portfolio of sound UK dividend stocks based on our recommendations. Our prerequisite is that any stocks selected for this let ter

must be liquid,well-capitalised with a strong free cash flow and a progressive dividend policy.

Our System

• Every month we will provide a write up of 3 to 4 stocks untilwe create a portfolio of 25 UK dividend stocks. This will be the HindeSight UK Dividend Portfolio #1

• You wiII bealerted by subscriber email intra-month when these stocks become a buy. Timing is critical to the strategy, not only buying quality stocks but buying them at the right time

• Theentry points willthen be recorded in the next month ly in the HindeSight UK Dividend Portfolio section and the stock(s) wr itten up in full

• We will run our winners but tend to rotate every 6 months depending on specific criteria which would elevate cheaper companies into the portfolio relative to stocks that had performed

• The basis for stock and portfolio selection is derived from our quantitative systematic methodology which screens these companies using the Hinde Dividend Value Matrix, (HDVMdl), a proprietary stock-rating system

• In the section on ETPs we will highlight our invest ment philosophy and the investment process behind our stock selections. This is the b*is of our dynamic risk and money management in our portfolio con struction for you. You can also read the stand-alone Hinde Dividend Value Strategy document to see the methodology behind our stock selection.

APPENDIX I

THE WAY WE THINK


“We have met the enemy, and he is us.” Walt Kelly

Our key to long-term performance investing is premised on the following:

• Systematic rule-based strategy• Systematic risk and money management• Occam’s razor, aka ‘K.I.S.S.’, Keep It Simple Stupid• Consistency• Discipline

All our investment ideas are rule-based methodologies driven by systematic and quantitative models.

Hinde Dividend Value Strategy

Hinde Dividend Value Strategy seeks to generate a total return from an actively managed basket of UK dividend-paying stocks. The strategy selects 20 highly liquid, mid-to-large capitalised stocks on an equally-weighted basis, which offer the highest total return potential. The 50%

Hedge version of the strategy would then be subject to a strategic Beta Hedge*, which is designed to cover 50% of the value of the UK stock basket at all times.

The 50% hedge is maintained using UK equity benchmark indices to reduce exposure to overall market volatility, but without reducing overall total returns to the market over the long run. The Hinde Dividend Value Strategy (100% Hedge) would deploy a full beta hedge at all times.

Hinde Dividend Value Matrix ®

The strategy employs a quantitative, systematic methodology, whereby FTSE 100 and FTSE 250 constituent stocks are screened using the Hinde Dividend Value Matrix®, a proprietary stock-rating system. We use the same system to select stocks for any of our strategies, long-only, 50% Hedge or 100% Hedge. The only difference is clearly the extent of the hedge on the exposure to the overall market.

APPENDIX II

HOW WE THINK


The basic premise of the strategy is to accelerate returns by selecting relatively high yielding stocks that offer the highest potential for capital revaluation. The dynamic rotation of stocks each quarter enables us to sell stocks where the capital revaluation and dividend has been captured, and use this additional capital to invest in more undervalued quality companies. If successful, this cycle of capture and re-investment offers the chance to significantly improve the total return generated by the Dynamic Portfolio.

The basis of the stock selection process is the Hinde Dividend Value Matrix®, which is a derived process that looks at 3 crucial variables:

* Beta is the stock’s sensitivity to market movements, e.g. if a share has a beta of 1.5 its price tends to move by 1.5% for each 1% move in the index

1. Dividend Screen

The top ranking stocks will be those offering a relatively high dividend. A composite of the following criteria comprises the Dividend Rank:

• Relative Dividend Yield• Dividend Capture• Payout ratios

The Relative Dividend Yield assesses if a company pays a higher dividend than the Index it derives from (the FTSE 100 or FTSE 250). The Dividend Capture criteria explain how quickly and how much of the dividend is paid at any point in time. The Payout Ratio gives a snapshot of whether a company will be able to maintain and grow its dividend. It helps us to assess how much of a company’s revenue, profit or cash flow is paid out in dividends.

The lower the amount of dividends paid out as a percentage of profits, the healthier future dividend potential will be. History is for once a good guide as to whether companies will continue to pay and grow their dividends. A stock with an excessively high yield relative to its sector or the overall market is invariably showing signs of heightened risk to its dividend sustainability and often the viability of the company itself. The screen incorporates a limit on yield dispersions from the overall market.

The strategy is emphatically not a yield chaser. It is the Performance and Value screens that are used to assess the total return potential of a stock by analysis of how undervalued it is relative to its fundamentals, sector and overall market index.

2. Performance Screen

The top ranking stocks have the poorest relative

performance to their index over multiple time horizons.

A composite rank of the following criteria provides the Performance Rank:

• Stock relative performance ranked over multiple time periods

• Average of time periods taken to select rank of stocks

3. Value Screen

The top ranking stocks by key fundamental criteria show stable fundamentals and exhibit upside momentum growth potential. The following are some of the criteria that provide the Value Rank:

• Value - Price to Book (intangible book adjustment), Free Cash Flow metrics

• Quality - Return on Investment and Earnings metrics

• Financial Stability - Debt levels, Coverage and Payout ratios

• Volatility - Stock variance, Dividend variance

• Momentum - Sales Growth, Cash flow metrics

• Liquidity - Minimum market capitalisation relative to index, Shares outstanding

Implementing the Hinde Dividend Value Matrix ®

The FTSE 100 and FTSE 250 stocks are ranked using the Dividend, Performance and Value screens. An equally-weighted composite rank is then taken of these 3 ranks, which provides a final ranking from which a selection of 20 stocks is made for the portfolio.

The stocks with the highest ranking are compiled for the FTSE 100 and the FTSE 250. The top 10 from each index are then taken, subject to diversification rules, which entail that normally only 1 stock per sector per index can be invested in. For example, if the top 10 stocks are all mining companies, the selection process would take the first of these and then move on to select the next top stock from another sector. As long as a stock has the highest score in its sector, the fact that it has appeared in the final ranking means it is already eligible for investment. In exceptional circumstances, it may be that more than one stock has to be selected from an individual sector.


DISCLAIMER

This newsletter is intended to give general advice only on the importance of dividends within the equity space. The investments mentioned are not necessarily suitable for any individual, and you should use this information in conjunction with other advice and research to determine its suitability for your own circumstances and risk preferences. The value of all securities and investments, and the income from them, can fall as well as rise. Your investments may be subject to sudden and large falls in value and you may get back nothing at all. You should not buy any of the securities or other investments mentioned with money you cannot afford to lose. In some cases there may be significant charges which may reduce the value of your investment. You run an extra risk of losing money when you buy shares in certain securities where there is a big difference between the buying price and the selling price. If you have to sell them immediately, you may get back much less than you paid for them. The price may change quickly, particularly if the securities have an element of gearing. In the case of investment trusts and certain other funds, they may use or propose to use the borrowing of money to increase holdings of investments or invest in other securities with a similar strategy and as a result movements in the price of the securities may be more volatile than the movements in the price of underlying investments. Some investments may involve a high degree of ‘gearing’ or ‘leverage’. This means that a small movement in the price of the underlying asset may have a disproportionately dramatic effect on your investment. A relatively small adverse movement in the price of the underlying asset can result in the loss of the whole of your original investment. Changes in rates of exchange may have an adverse effect on the value or price of the investment in sterling terms, and you should be aware they may be additional dealing, transaction and custody charges for certain instruments traded in a currency other than sterling. Some investments may not be quoted on a recognised investment exchange and as a result you may find them to be ‘illiquid’. You may not be able to trade your illiquid investments, and in certain circumstances it may be difficult or impossible to sell or realise the investment. Investment in any of the assets mentioned may have tax consequences and on these you should consult your tax adviser. The opinions of the authors and/or interviewees of/in each article are their own, and are not necessarily those of the publisher. We have taken all reasonable care to ensure that all statements of fact and opinion contained in this publication are fair and accurate in all material respects. All data is from sources we consider reliable but its accuracy cannot be guaranteed. Investors should seek appropriate professional advice if any points are unclear. Ben Davies and Mark Mahaffey the editors of this newsletter, are responsible for the research ideas contained within. They or any of the contributors or other associates of the publisher may have a beneficial interest in any of the investments mentioned in this newsletter.

Disclosures of holdings: None relevant to any content discussed within this issue of the newsletter

This score is derived from 3 inputs that have been obtained from all the external analysts at leading institutions who are covering the stock:

1. The 12 month target price in relation to current price

2. The number of analysts covering the stock

3. The recommendation analysis, e.g. STRONG SELL, SELL, UNDERPERFORM or HOLD

This score is used to observe the other analysts’ view of the stock and is helpful when understanding the methodology that other analysts use to determine their 12-month target price. We ultimately get a blend of price targets that is based on different valuation metrics.

EAS Score Output:

1. The combined score will vary from 30-702. A stock with a lowest score of 30 shows the majority

of analysts not only have a full sell/underweight recommendation, but also a low 12-month target

price in relation to current price.3. A stock with the highest score of 70 shows the majority

of analysts not only have a full buy/overweight recommendation, but also a high 12-month target price in relation to current price.

Note:

On a standalone basis, the EAS score must be viewed in the following context:

• Equity analysts issue far more positive recommendations than negative

• If all analysts are overwhelmingly bearish or bullish, then this can signal a contrarian position be held, but this is determinate on the where the stock is valued.

However, in conjunction with the HDVM ®, we have found the score to be useful when it is high or momentum is turning higher, as this suggests that the stock offers deep value.

EXTERNAL ANALYST SCORE (EAS)

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