 Good day, fellow investors. Perhaps one of the most requested stocks for me to analyze were tobacco stocks. And that's logical because we have seemingly strong fundamentals, declining stock prices, high dividend yields and difficult to understand industry because there are lots of uncertainties, lots of risks. So in this video, we'll dig into the industry, we'll discuss Altria, Philip Morris International and British American Tobacco. See their fundamentals, see their businesses, what is the management doing, what you can expect over the long term and then try to figure out an investment strategy if you have to be invested and then also compare it to others. Compare the risk and reward, calculate the present values and everything that comes into the package of looking at the sector. So let's immediately start with Altria's fundamentals. So as I said, stock prices down, Altria really badly hit over the last year, year and a half, but very good over the five years. British American Tobacco very bad over the last five years and extremely bad over 2018, down 52%. But let's look at the fundamentals. As I said, Altria's fundamentals look very, very good. We have line up, revenues are up, even if they have been stagnant for the last seven years. Line two, net income had been stable, but exploded in the last three years. Operating cash flows, line three have been constantly positive and significantly increased in the last 12 months. And CapEx spending is really minimal, which leaves plenty of room for high free cash flows, which leads to dividends, buybacks, etc. As I said, dividends, buybacks, earnings per share growth of 9%, 21 billion dividends paid, six billion repurchases. So total shareholder return 180% over the period, very, very, very good with dividends increasing. So you might say, okay, this is a great business. I really want this stock in my portfolio. However, just to note on the earnings per share, they say, we have seen that they were very high in the last years, but those are due to special items. The reported earnings per share were higher in 2007 due to the tax items that increased earnings by $1.91, while earnings in 2016 were higher due to the gain on the AB, IMBEV, SAB, Miller business combination, also about by $4.6. So you cannot really take the real earnings there, because the actual earnings for the company have been 3.3 in 2016, 3.39 in 2017, and are expected to be given the guidance around four in 2018. This means that the adjusted average price earnings ratio, if I use three year or severage earnings of 3.47, the current stock price is 50, so the price earnings ratio is 14. The price to book value is six, so we can't really focus on that. Now what's the reason for the stock price decline? Now a company like Altria, you have to look it as a cash cow. So we have a stagnating business. Really hard to grow when cigarette usage volume is declining. So the only thing you can see is not invest anything in capital expenditures that they are actually not doing, and really milk the cow as much as you can. So it's a cash cow in the business cycle. However, when you have a cash cow like that, then the only thing you can base your valuation on are future cash flows. So it could be like a bond, but it's even worse because it's more like an annuity, because when those cash flows dry up eventually in time, there is no principle that gets back to you. So that's also something you have to take into account when discounting future cash flows. Fortunately for Altria shareholders, the dividends have been growing as they work on efficiency over time, but the key is that, okay, for how long will these dividends grow? For how long will the yield be 5.7%, which is a good yield? And for how long will the dividend increase? The tobacco business, as they say here from the World Health Organization, kills up half of its users, so leading cause of debt illness and impoverishment. The governments know it and they are trying to prevent it. So the trend is actually pretty clear when it comes to cigarettes. And there are also other threats like FDA regulation on nicotine and cigarettes. And I always urge people to read the annual report and read the risk section of any stocks you might be thinking of investing in, because it's pretty detailed, as you can see here in the video on YouTube, and you can see how much of that is already discussed. Litigation, goodwill impairment, potential tobacco prices and who knows what ghosts can come out of the closet. So please read the risk report in any annual report of any stocks you can invest in. And sales of cigarettes, the volumes have been declining as the tax have been going up. And therefore, you have to discount the future cash flows, try to estimate them to see for a value. So let's estimate, let's discount the value of most dividends over the next 20 years. I assume, let's say dividends grow over the next six years, then they are stagnating and then they decline at 10% per year from 2027, 2028, up to 2037, because let's say people stop smoking. This is of course all an estimation, but those are the estimations others are using. And if the company's result will be better than the estimations, then you will see good stock prices, like it has been the case over the last 10, 15, 20 years. If the results will be lower than estimations, you will see bad stock prices. And then that's also always the uncertainty when it comes to investing. So I've put that all in a model, the discount rate, let's take 5%, which is very low for stocks. And then I get the present value for the dividends for the future for $50, similarly to the current stock price. I used the final value, dividend 1.79, declining dividends, so 10% yield expected. And then I got also final value of 17 for the stock. Now the key when it comes to discounting future cash flow is what is the discount rate you will use. And here just the fluctuations in the discount rate have a big impact on the stock price. And this is one of the most important things that put pressures on tobacco stocks is the interest rate. If we look at the 10-year treasury for the US government, the interest in 2016 was 1.4% then it went 2017 2%, then again close to 2.2%, but that coincides with the highest peaks for this dividend cash flow chaos, because those were influenced by the interest rate and the rate you use when you discount future cash flows. Now the 10-year treasury maturity rate is much higher at 3%. And now you're not happy with a dividend yield of 4%. You want a dividend yield of 5%, 6%. And this converts into a much, much lower stock price. And this is why you see the volatility of stock prices. So interest rates, risk-free interest rates on treasuries have a big impact on stocks. For example, if I keep a constant dividend of $3 for Altria, when the market expects a 3.8 dividend yield, the price of the stock will be 78.94%. If the market require a 6% dividend yield, the price of the stock will be 50%. And this is exactly what we have seen happening in the last few years. Low premiums on stocks, low expected dividend yields, stock prices are higher, like 2016 stock prices are going up. And then when the interest rate changes, stock prices are declining very strongly. On top of that, we have to also look at the business. So we have cash cows. And then when things go south, when it's not easy to milk that cash cow anymore, then the management can say, okay, we can do nothing, but they're not hired to do. They have to do. They teach you in school that you always have to do, do, do when you are in business, which is not a really smart thing when you are an investor. But they focus on doing and they do things which might be very, very stupid things to do. So apart from milking the cow, they decided to pay 12.8 billion of your cash that shareholders were supposed to get for a 45% stake in the US leader in eVapor at a 33 times sale valuation, which is completely crazy. So from a cash cow, they focused on strategic rationale, fastest growing entrepreneurial success, volume growth opportunity, leading US eVapor company, international growth, et cetera, et cetera. So from a cash cow, they turned the company into a growth stock, potential stock. And to do that, they took 14.6 billion of that, which is a certainty. And they also paid 1.8 billion for a stake in the Kronos group. So suddenly over the last year, Altria has switched from milking the cow to fattening the cow. And when you give too much fat, too much eating to a cow, it can explode. And also the investors who were in Altria were happy to milk the cow. Now those investors are not that happy that their cash goes into growth, risky opportunities. And that's a different business model. So that's also something you have that increases the uncertainty. And when the uncertainty increases, you want to be paid more. And therefore the stock also goes down, especially when the growth stories that have fueled the market exuberant market slow down on British American tobacco similar situation. However, there is an FDA ban on mental that might hit 25% of their profits in the US. And that's another reason for the pushdown. And then something that Altria is doing now, they have been doing also for the last 10 years, their debt. The only certainty when it comes to investing is debt. And they have increased it from 20 billion to 80 billion, the total liabilities over the last 10 years. If you want certainty in investing, look at debt, because there is a certainty that you have to repay that and that the interests are going to go up, especially if you have seen 10 years of zero interest rates from the Fed. So this is double whammy for British American tobacco. And that's why their stock has been hurt much stronger than Altria. They have bought Reynolds, a peak tobacco, where the debt will remain and interest rates have been going up for a while now. And this is a perfect example of short-term thinking of the management. We compare short-term interest rates, we compare short-term earnings, short-term profits and then, okay, acquiring Reynolds at 48 billion valuation is a smart thing to do. But all those things change and what was smart a year and a half ago might not be that smart three years from now. And that's something the management will never grasp because they are focused on their next years, bonus, etc. So there is very little management focused on the long term. And plus, the strategy of all these tobacco companies over the last three decades has been always acquire, acquire efficient, making more things more efficient, acquire and grow. And it has worked perfectly. But that is like a pyramid scheme. At some point, the acquisition becomes too expensive. Reynolds acquired some other company three years ago also using debt. So if you use debt to acquire, that can all just go up to a certain limit. And then like a pyramid, like a house of cart, it all crashes down. It comes down chasing you because the burden becomes bigger, bigger and bigger. And if you have debt, you know that if your business slows down, the debt is a certainty. And if your business slows down, your ratings will go down and your interest rates will go up. So the burden will be bigger, bigger and bigger. Philip Morris International also under pressure, downgraded to underperform lower price target, because next generation products, users in Japan, US, UK, slower progress on heated tobacco products, etc. etc. will hit the earnings growth models and therefore have a lower valuation, especially if you use higher interest rates. So we will see what will happen there. But the fundamentals also look good there. But it's again, okay, what will be the dividend in five to 10 years? And now we come to the question, are tobacco stocks a bargain? Should you invest in them? Well, my view is always, okay, this is the dividend yield. There can be a good case where the dividend stays strong and even grows over the next 10 years and only then declines. But we can see lower dividends also from the next two years. So there is a good scenario. There is a bad case scenario, FDA bans on mental and things like that, or nicotine control, all lower profits and can make the situation difficult. So those are the risks. And when I forward those risks into a model, I want to be paid for those risks, especially in a negative trend in a declining trend. And that's the key for me when investing in such stocks. I'm not going to invest just for the record. The key is, okay, if there are so much, is there is so much risks, I would need to be paid for to take those risks. And there is always the story, okay, should I invest in a business that will grow over the next, or that's highly likely to grow over the next 20 years? Or should I take the, should I milk this cow over the next 20 years? If I just compare two dividend valuation models, one, the first one that we already did for Altria, this time I use a discount rate 10%, the sum of present values at the price or next ratio of 10 for the terminal value in 2037 is 33. If I start with the dividend of $1, so 33% of Altria's dividend and increase the dividend by 10% over the next 20 years, which is possible, then the sum of present values is pretty similar, especially as it is a growth stock, it deserves a pre-a ratio of 15 after 20 years. So you have to choose, okay, am I going to milk this cow or am I going to go into a growth dividend positive trend? Just for an example of a positive trend, it can be, for example, Daimler, will this company be selling more cars in the next 10 years, electrical, everything Uber, whatever, probably? And there is also higher dividend yield due to the fear of the next upcoming recession and due to the debt they have, but that's how they change their business model, that's something else we can talk in another video. So the key for me, just my personal opinion is, I think that I can find dividend yields of 4, 3, 4, 5% if I need to buy such a business that will be growing over the next 20 years. Unlike the tobacco industry that might grow, and this is the growth projection, is what leads attracts people to them. But when the dividend starts declining, which will, because all those companies had 2% down in volume sales globally, and we have seen the chart how the sales are actually going down, so the dividends will go down, the cash flows will go down, especially if they spend the cash flow to acquire things or take debt that will put a burden on their income statements, a bigger burden as interest rates go up and as their businesses decline as the downgrades come, as the credit ratings go down, and therefore I prefer a stock that might have a little smaller starting point, but a higher ending point when it comes to dividends. And the thing you have to do is, okay, compare all the scenarios, the bad, the average, and the good scenario, compare it to other 50 dividend stocks, the bad, the good, and the average scenario, and then try to deduct the present value, compare those present values. And then we will have a good perspective, okay, this might happen, this might happen, try to attach probabilities to that. And for now, I think that I can find, with a lot of work, I can find those positive dividend yields that are not that much more expensive than Altria and all other tobacco stocks. So I'm not going to cover the sector, I don't know, I'm currently looking at natural gas, LNG, that has a positive trend upwards over the next 20 years. And if I can find something there with higher dividends, we have discussed Gazprom, which is a crazy Russian stock, but it pays a higher dividend, and it is likely that the dividend will go up no matter how much Putin squeezes money out of the company. They are simply producing so much cash that the risks are, I would say similar, tobacco, Gazprom, so you have to compare those companies and then see, okay, what will be better over the next 10-20 years? And what is more likely to happen? The situation in Russia going worse or people start smoking more? So just babbling about ideas there, but thank you for watching and I'll see you in the next video.