First published in the Daily Maverick 168 weekly newspaper.

Protracted battles with the Nigerian regulator wiped millions of rands in value from MTN as the share price fell from more than R200 to less than R70 between 2015 and 2018. Tussles with US regulators over bribery allegations in the Democratic Republic of Congo kept Glencore’s share price suppressed until new management began to sweep the cobwebs out. And discount retailer Pepkor will not see its value unlocked until the uncertainty about Steinhoff is removed – and even then trust issues may linger.

Investors have learnt, often painfully, that environmental, social and governance issues matter. Sometimes more than operational issues.

So when two reports were released this week suggesting that tobacco multinational British American Tobacco (BAT) ran a mass surveillance operation and informant network in South Africa, bribed the late Robert Mugabe and made questionable payments totalling $600,000 in 10 other African countries, investors sat up and paid attention.

“Investors have to care,” says Zwelakhe Mnguni, chief investment officer at Benguela Global Fund Managers. “These are material allegations, and while there is no legal evidence yet, this is concerning. Any company that investors have money in has to conduct its business within the laws and moral standards of the country.”

Aside from the bribery allegations, the problem that BAT and its listed peers are facing is that the water has been rising around tobacco companies for some time. Tobacco has long been among the exclusions in ethical investors’ portfolios, but more recently investors looking at environmental, social and governance metrics have also considered the implications of holding tobacco stocks. Some investors believe that the harmful consequences of smoking are at odds with the UN’s Sustainable Development Goals, specifically number three, which promotes universal good health and wellbeing.

“Illegal surveillance and bribery? This type of thing coming to light doesn’t help what is already a challenging investment case,” says Pieter Hundersmarck, global portfolio manager at Flagship Asset Management.

By that he is referring to the fact that the share has lost almost half of its value over the past few years as the cigarette market shrinks and smokers switch to alternative products such as vapes and heated tobacco, known in the trade as New Generation Products (NGPs).

BAT has been slower than some of its rivals, notably Philip Morris, to adapt to changing trends, choosing instead to sustain revenue with price increases, cost-cutting and acquisitions that have added a sizeable debt burden. Yet management is determined to address these issues and recent results suggest that the ship may be turning around.

The difficulty faced by fund managers is that the investible universe for South African funds regulated by the Pension Funds Act is becoming narrower. And for investors looking for rand hedge stocks – companies like Sasol and Richemont that earn a material percentage of their revenues in non-rand currencies and therefore benefit from a weakening rand – choices are limited.

That’s why British American Tobacco, a Fortune 500 company and owner of Pall Mall, Rothmans and Camel cigarettes, remains popular with local investors who appreciate the generous dividend and hold a sizeable chunk of the company across at least 370 funds – excluding index trackers.

“South African fund managers’ exposure comes to about $2.014-billion or R29.3-billion at a rand rate of R14.56/US$,” says Mnguni. “The point to make is whether exposing R29-billion worth of clients’ capital to governance risks is acceptable or reasonable?”

Neither BAT Plc nor BAT SA is giving interviews, but the company has categorically denied the allegations contained in the reports, which were based on whistle-blower  accounts, leaked company documents, invoices, emails and court records analysed by researchers at the Tobacco Control Research Group at the University of Bath.

“BAT emphatically rejects the mischaracterisation of its anti-illicit trade activity by the BBC and The Bureau of Investigative Journalism (TBIJ),” it said in a statement. “Allegations of this nature are not new and have been covered extensively in various news media over several years.”

The company adds that it cooperated with the UK’s Serious Fraud Office investigation, which in January 2021 closed its investigation into BAT, its subsidiaries and associated persons, without charge.

“Investors are putting pressure on companies to clean up their acts – whether it’s environmental, social or governance related,” says Iain Power, chief investment officer at Truffle Asset Management. “In South Africa the investible universe is shrinking, and in some ways we are forced to choose the cleanest dirty shirt – whether it’s Sasol, Glencore or even Eskom, which is unlisted but powers us all. If we were sitting in Switzerland with a universe of 25,000 stocks to choose from, it might be a different debate.”

That said, ongoing engagement with the company has made him confident that the BAT CEO, who has been at the helm since 2019, is working hard to improve both governance and social issues.

Certainly, when it comes to social issues, the company is trying to make up lost ground. Competitor Philip Morris expects to discontinue the sale of conventional cigarettes in the UK by the end of this decade, which indicates the pace of transformation. BAT has adopted a strategy that will keep its irons in the fire of both combustibles and NGPs.

In its results for the six months to June, BAT reported a robust performance in new-generation products, with sales up 50% in constant currency to £883-million, with vaping growing by 59%, heating products by 38% and modern oral by 63%. The firm contends that it remains on target for £5-billon in NGP sales by 2025, which should translate into a break-even level of profitability.

“BAT is a big offshore rand hedge,” says Power. “We understand the warts and risks and believe the stock has priced these risks in.”  

There is no doubt that South Africa is starved for global exposure, concludes Hundersmarck. “This forces fund managers to look past some of the concerns that they may have. But you have to consider the investment case: management might be doing the right things, but with these allegations swirling around, can the stock rerate?”

These are questions that local fund managers cannot ignore. DM168

This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.