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Smoke and mirrors: tobacco-related revenues are important for managing investment risks

At present, companies that are listed on the New York Stock Exchange or NASDAQ (“listed companies”) that sell tobacco-related products are not required to report the amount of revenue that they generate from those products. As a result, investors are unable to quantify their exposure to tobacco-related revenues.


Pella sent a letter to the U.S. Securities and Exchange Commission (SEC) requesting the commission to develop rules to require public companies operating in the retail sector that are involved in selling tobacco products to disclose their revenue from those products (https://www.pellafunds.com/lettertosec). You can support this initiative by signing this petition at change.org (encourage the SEC to develop rules that require retailers to disclose tobacco revenue).


Understanding tobacco-related revenues is important to manage investment risks and ensure investments are aligned with investor values. Without this data, shareholders in retailers could unintentionally have more exposure to tobacco products than what aligns with their values. Further, disclosure of tobacco-related revenues is important to understand the risks of declining sales of tobacco products.


CVS Health Corp (“CVS”) provides insight of the impact from declining tobacco sales. In Feb-14 CVS announced that it would cease selling tobacco products at pharmacy stores across the US[1].


At the time of the announcement CVS estimated that this decision would cost it approximately 17c in lost EPS, which Pella calculates equates to 4.5% of the prior year’s (FY13) EPS. In its FY15 Report 10-K (“10-K”), CVS reported that the absence of tobacco and the estimated associated basket sales reduced front store same store sales by approximately 5.2%, while Pella calculates tobacco products accounted for less than 3% of that segment’s sales. These figures demonstrate that tobacco-related products influence the sale of other products, which in aggregate have a material impact on certain retailers’ results.


It is well understood that investing in a company means being an owner of that company. This necessitates an understanding of whether an investment aligns with investors’ values. Profiting from tobacco may be unaligned with some investors’ values. Reporting revenue from tobacco sales will allow investors to assess whether an investment is suitable for their portfolio, based on their values.


Using the ‘As You Sow’ (“AYS”) database, which sources data from Morningstar, Pella calculates there are 397 mutual funds with $615Bn in assets, a sustainability mandate, and the highest two AYS tobacco grade of ‘A’ or ‘B’, offered in USA as of September 24, 2023[2]. Many, if not most, of those funds have a stated objective to avoid investing in tobacco-related businesses.


For example, one of the largest funds in the sample, Putnam Sustainable Leaders Fund, excludes companies that generate more than 10% of their revenue from tobacco[3]. As of June 30, 2023[4] that fund was invested in Dollar General, a company that generates an undisclosed percentage of its revenue from cigarettes. This is not a criticism of Putnam, which is a highly reputable fund manager and would have researched Dollar General’s tobacco-related revenue. However, the fact remains that under the current reporting regime it is impossible to entirely substantiate Dollar General’s exposure to tobacco-related revenue. This is a considerable concern for the huge number of investors seeking to limit their exposure to tobacco-related products.


Figure 1 is a non-exhaustive list of companies that are likely to be impacted by the proposed petition. It includes all companies with a market capitalisation greater than or equal to $100m and operate in the Security Industry Classifications codes 5141, 5331, 5339, 5411, 5499, 5541, and 5912, and are positioned to have tobacco-related products in their merchandise mix.


Some of Pella’s key observations from the table include:

  • Most companies that sell tobacco products make some mention of selling those products in their 10-K, suggesting that most companies already recognise that selling tobacco-products is a reportable activity.

  • Some companies (Albertsons, BJ’s Wholesale Club, Kroger Co., PriceSmart, Village Super Market, Weiss Markets) that are reported to sell tobacco products by online sources do not make any mention of selling tobacco products in their 10-K.

  • Only one company (Murphy USA) provided guidance of the amount of revenue generated from tobacco-related products.


Figure 1 - Companies that could be impacted by the proposed petition

Company

Sell tobacco products?

Mentioned in annual report?

% revenue from tobacco

Albertsons Companies

Yes

No

No

BJ's Wholesale Club

?

No

No

Casey's General Stores

Yes

Yes

No

​Costco

Yes

Yes

No

CVS Health

No

n/a

n/a

Dollar General

Yes

Yes

No

Dollar Tree

Yes

Yes

No

Ingles Markets

Yes

Yes

No

Kroger

Yes

No

No

Murphy USA

Yes

Yes

Yes

PriceSmart

Yes

No

No

SpartanNash

Yes

Yes

No

Target

?

No

No

Village Super Market

Yes

No

No

Walgreens Boots Alliance

Yes

Yes

No

Walmart

Yes

Yes

No

Weiss Markets

Yes

No

No

The absence of a requirement to report whether a company generates revenue from the sale of tobacco-related products is an obvious impediment to the above analysis. It creates uncertainty whether the absence of disclosing tobacco-related revenue is due to the company not selling those products or choosing not to disclose those sales.


Another issue is that without the requirement to report tobacco-related revenues, few companies will do so for competitive reasons. A reporting company might be providing its competitors with more information than what they receive in return. Pella was made aware of this issue previously when it requested its investee positions to disclosure their revenue from tobacco-related products. Mandatory reporting will overcome this issue.


Developing rules to enforce tobacco sales disclosures will enable investors to assess the risks of declining tobacco sales, and whether investment candidates are aligned with their values. Further, companies reporting this data will not be at a competitive disadvantage relative to its peers.


This is a rare win-win situation, and we would extremely grateful if you support this initiative, by signing the petition.



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