Is Cannabis The Future For Big Tobacco? - British American Tobacco (NYSE:BTI), IMPERIAL BRANDS PLC ADR by

By Barbara Pastori, Prohibition Partners.

A few weeks ago, Philip Morris (NYSE:PM) CEO Jacek Olczak made the news with a series of seemingly counterintuitive remarks. Namely, that the tobacco giant may soon stop selling cigarettes in the UK, while urging the government to ban smoking altogether. Olczak said the Marlboro brand will “disappear”, and that “the first choice for consumers is they should quit smoking."

While this might seem like a deliberately provocative stance - to some extent - it's also broadly in line with the direction the tobacco industry has taken over the last few years. It may also prove to be a sensible business strategy. Most enduring companies do, at some point, have to reinvent themselves to survive.

Technological developments are a common driver of change, but pressure can also come from wider changes in consumer behavior. It’s more difficult, for example, to find a company still selling the same product after 100+ years than it is to find a company that successfully changed its line of business. In some cases, the best way to protect shareholders' interest is to imagine different approaches and embrace change, rather than drifting comfortably on a sinking ship.

Tobacco and Cannabis: A Perfect Match

The global exodus of consumers from the tobacco market means this industry is now at a turning point, where alternative or additional product lines are vital to the future security of its companies. Among the many alternatives that the tobacco industry is exploring as part of its broad reimagining of its future, cannabis surely represents an opportunity. Numerous tobacco companies have already made investments in the cannabis industry over the past few years, including Altria, Imperial Brands (OTC:IMBBY), and most recently British American Tobacco (NYSE:BTI).

But why does cannabis seem to be particularly appealing for Big Tobacco? The first association that comes to mind is smoking, but there is a lot more to the story. Here are a few key points that, in my opinion, make cannabis a particularly compelling case for tobacco companies.

1. Technological Advances

The two industries have shared the benefits of certain technological advances. Whenever a breakthrough is made in facilitating the consumption of combusted organic material in a more safe and efficient way – as is the case for vaporising and e-liquids – both industries stand to gain.

2. Diverse Products

Big Tobacco's interest may also go well beyond smokables. Investments are still at an early stage but, from our vantage point, we’re noticing interest in products from the entire cannabis range. Tobacco is looking to offer consumers an alternative to smoking; the cannabis industry’s evolution, which has brought a huge variety of products to the market - like edibles, oils and topicals - can serve as a reference point. At Prohibition Partners, we’re noticing increasing interest in these alternatives. This is quite remarkable for an industry that, for so many decades, thrived on a relatively limited range of products.

3. Production Processes

Cannabis and tobacco rely on similar production processes, i.e. cultivation of a warm-climate crop and subsequent processing. This explains the interest in cannabis of countries such as Andorra or Malawi, who have in the past relied heavily on tobacco cultivation as their prime farming product.

4. Supply Chain and Distribution

Both industries share similar distribution channels as products are usually sold in brick and mortar shops, which sell regulated products, such as tobacconists, off licences and dispensaries. In all of these points of sale, retailers need specific permits and are bound to strict codes of conduct.

Likewise, the marketing for both cannabis and tobacco products is highly restricted as countries and states have specific rules on where (i.e. print, radio, digital communications, television) and how (i.e. health claims, free sample restrictions, sponsorships) companies can advertise. Thus, by having previous experience with heavily regulated products it would be fairly easy for Big Tobacco to transition into the cannabis retail market.

5. Marketing Opportunities

Investing in cannabis could also be a huge marketing opportunity for tobacco brands. After all, fundamental product differentiation in the tobacco industry is slight, so fortunes have been built primarily on iconic advertising. However, in recent years, regulatory crack-downs and changes in consumer perception have made it more and more difficult to promote tobacco brands. Investing in cannabis would not only be a way to spend some marketing budget in a less regulated environment, but the mere association to cannabis could help the industry improve its reputation in some key strategic segments of its target audience, particularly among younger people.

6. Highly-Regulated Markets

The tobacco industry knows how to operate in a complex and heavily regulated environment. Because of that, it has been forced to develop strong public relations and lobbying capabilities - by applying that influence to cannabis, tobacco could have a significant impact in shaping a regulatory framework that is still nascent. Altria activism in the US is a clear example of that.

7. ESG Rating and Sustainability

Finally, a transition into the cannabis market has its advantages for publicly traded tobacco companies as it would enable them to improve their environmental, social and corporate governance (ESG) ratings. ESG ratings have become increasingly important for publicly traded companies, as investors and analysts factor in these ratings when they are determining the long-term risk of a company’s stock. Adding products such as CBD from outdoors-grown hemp (a carbon negative crop) to their range could improve Big Tobacco’s ESG ratings, and enable them to take part in shaping the progress of the emerging industry towards more positive environmental and social outcomes.

Investing for the long term

When you consider all these factors together, the relationship between tobacco and cannabis could become more than just a marriage of convenience. Tobacco corporations have many of the requisite skills and resources needed to succeed in the world of cannabis, while cannabis manufacturers have overseen a process of transformative innovation that tobacco giants would do well to learn from - the relationship could be symbiotic.

Cannabis cannot and will not be a substitute for tobacco. This is not, however, what the tobacco industry needs. It critically needs new products to diversify its business, so the incorporation of legal cannabis seems like a logical step for tobacco corporations to consider.

Tobacco has a long enough shelf life to remain hugely profitable for some time. Cannabis is not a quick fix for declining revenues over the short term; rather, it’s an opportunity for the long term. It could be a critical forward-looking investment for an industry that wants to remain the lifestyle staple that – for better or worse – it has been over the past 100 years or more, and not become the next great empire to go up in smoke.

BTIBritish American Tobacco PLC

$62.563.30%

Overview

IMBBYIMPERIAL BRANDS PLC ADR by Imperial Brands PLC

$38.233.77%

PMPhilip Morris International Inc

$182.632.78%

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