Tobacco was the most profitable industry for U.S. stockholders over a 115-year span. But tobacco was also profitable for everyone - from raw material to retail.
FARMERS
Each fall, farmers supplied the leaf tobacco. How did they fare economically? Tobacco had the second highest profit per acre of any crop in the world. (Only a grove of an obscure exotic nut was higher.)
Comparing the profit from an acre of tobacco with an acre of wheat is instructive. While the profit margin for each was about 22%, there were big differences in the costs and the dollars of profit per acre. Wheat was sowed and harvested with equipment – tractors, seed drills, and combines. The equipment cost was justified only if it was used on large acreage tracts. Machinery cost was 29% of price while labor was 3.6%. Since nearly all the work was done mechanically, the manual labor was less than two hours per acre, about $16.
In tobacco farming, machinery was only 15% of price. And looking back to the 1930s–40s, tobacco required almost no equipment. The crop was planted, tended, and gathered with long hours of backbreaking labor and a few mules. Even with machinery, labor is still 22% of the cost of producing an acre of tobacco, more than five times the percent in wheat farming.
But the difference in profit dollars per acre is dramatic. Wheat produces $96 per acre, while tobacco produces $878, nine times as much. A family with teen-age children could grow five acres of tobacco to supplement the income from the parents’ jobs and produce over $8,000 of badly needed cash income. (See Wheat and Tobacco – Comparative Economics. Data are from the 1980s, but relative results have been consistent for decades.) In a future post we will give details about “putting out a tobacco crop.”
CIGARETTE MANUFACTURERS
In the mid-1980s, RJR’s Vice President of Human Resources would point out to newcomers the railroad track at the Whitaker Park cigarette plant. He would ask, “What do you think leaves in those boxcars? Cigarettes. And when they come back, what do you think they have in them? They are loaded with MONEY.” Symbolic, but true.
In 1982, the old Whitaker Park plant produced $523 million net operating profit using just $850 million of operating assets, a 62% return. (The depreciated asset values were understated. Using replacement value, the return would have been about 40%.) In 1986 that profit had risen to $802 million, and by 1999, the new Tobaccoville plant produced $469 million profit, a 20% ROE, and $1.2 billion cash flow even as cigarette demand was falling rapidly. (Chart I)
A business that can return a dollar of net profit every five years for every dollar that the owners invest is a cash machine. At Tobaccoville, 72 cash machines under a single roof.
A key number is the profit per 1,000 cigarettes —$2.51 in 1982. In 1986 and years following, the figure rose to over $4.00, reflecting greater productivity. A new cigarette machine doubled production to 8,000 cigarettes per minute, and by 1988, each machine produced a profit of $39.90 per minute, so that the two factories generated almost $5,000 net earnings per minute of operation. (Chart II)
DISTRIBUTORS
And the distributor who supplied the retail stores? A group of RJR executives made a Far East junket.
They met with the local distributor in Hong Kong. It is customary for suppliers to make gifts to their customers. But this customer (the distributor) was grateful for the opportunity to carry RJR products. He gave each of the RJR entourage a Rolex watch. That gift certainly suggests he had a high margin.
“WOULD YOU RATHER HAVE A FAST DIME OR A SLOW DOLLAR?”
This is what Yancey Ford, Vice President of RJR Tobacco Sales used to ask his retailer customers.
At a drugstore in Manhattan in 1949, a cigarette salesman restocked daily. With an average inventory of $155, the store’s annual cigarette sales were $36,450, an inventory turn of two hundred times a year. The return on capital and floor space was almost incalculable.
A Winston-Salem newsstand in the 1970s was open Saturdays and Sundays, 12 hours each day. In a typical weekend, cigarette sales were 3,600 cartons. The owner said, “We didn’t make much money on them.” He meant that the gross margin per pack was small, $.04 after taxes, but at that volume, profits were about $1,400 on a $29,000 inventory that turned in four days. The return was 4.8% EACH WEEK, minimum of 258% a year! And this was from a ‘fast’ $.04, far from a fast dime.
Cigarette profit per square foot of floor space was 10 times that of the next best store item. Cigarettes were displayed near the checkout counter to remind customers – “Oh yes, I forgot. I need a pack (or a carton).”
PROFITABILITY OUTLOOK
Such stories are history. The future is unknown. Will “nicotine delivery systems” remain profitable? Security analysts must answer the question. In my last post, I cited the work of two analysts – Lawrence Hamtil in the U.S. and Jonathan Fell in London.
Another highly regarded analyst in London, Rae Maile at Panmure Gordon, has followed tobacco stocks for over 30 years, and provides excellent research on both history and outlook.
These experts give insight to investors in the multi-billion-dollar tobacco companies.