Should You Give Up Fags and Booze, plus Coverage of Babcock and Babylon

The title of this article refers not to your personal habits, but whether investors should give up on holdings in tobacco and drinks companies. Yesterday British American Tobacco (BATS) dropped 10% after the Wall Street journal reported that the US Food and Drug Administration was planning a ban on the sale of menthol cigarettes. They contribute a significant proportion of BATS profits.

Aside from this possible temporary issue, the key question for investors is whether to hold tobacco stocks at all. Apart from the ethics of selling products that kill people (and as a former smoker I am not too concerned about that as many people participate in dangerous behaviour of other kinds despite being warned), the key question is whether you should invest in such companies. With BATS on a prospective p/e of 10 and a yield of 6.7% (according to Stockopedia) it might seem attractive. But the share price has declined from a peak of 5,530p in June 2017 to below 3,000p now.

Smoking in the developed world is falling – down to under 15% of the population in England according to the latest statistics. But it’s still growing in less developed parts of the world such as Africa and the Middle East. However, with more Government intervention and better population education, one has to face up to the fact that it is likely to be a declining market sooner or later. It’s obviously a sector very vulnerable to Government interference which are usually ones to avoid. So I suggest investors should not just give up smoking, they should give up on tobacco companies. Investing in companies operating in declining markets is always tricky as few managements accept the party is over and tend to continue in their same old ways with damaging effects to their health – just like smokers.

The next addictive product to talk about is alcohol which is also vulnerable to Government regulation. Diageo (DGE) is a company with leading brands in the sector. Strong brands can enable companies to earn a superior return on capital and some Annual Reports from the company talk about nothing else. Indeed they have so many brands that they recently announced they were selling off a few of them. Does that make sense? Probably because does one really need multiple gin and whisky brands? Personally I find great difficulty distinguishing the multiple brands of gin now on the market – most of them seem to be marketing gimmicks rather than really different products with different tastes. By the time they are diluted with your favourite tonic such as Fevertree, there’s not much difference. Diageo has one particular strength in that booze sales are less affected by general economic trends just like tobacco. People don’t give up drinking and smoking in a depression so are unlikely to be affected by Brexit, whatever the outcome. But health concerns and Government intervention are still risks – for example Diageo has potential problems in India. But I consider the risks worth taking in Diageo so I do hold a few shares in the stock.

Babcock International (BAB), the defence contractor, is another stock to avoid if you have environmental or social concerns. But that’s not the main reason the share price has been declining of late – the share price is down from a peak of about 860p in June this year to about 600p. The prospective p/e is now 7.3 and the yield about 5% which certainly makes it look cheap.

One reason for the decline is an attack by an investment firm called Boatman Capital. They allege (to quote from their web site): “Babcock has systematically misled investors by burying bad news about its performance. We believe it faces potentially massive exceptional costs, revenue pressure and declining margins”. They also suggested the company’s relationship with the Ministry of Defence had soured. Nobody knows who is behind Boatman and BAB say they are “untraceable” so this looks like yet another of those shorting attacks preceded by a damaging report that mixes up mud-slinging and innuendo with dubious financial analysis and a few real facts that add credibility. BAB issued a response to the Boatman report yesterday which is worth reading. Babcock investors can download the report from the Boatman web site.

Such attacks have been common among smaller cap stocks for some time. Sometimes the attacks have an underlying basis of a few facts, but sometimes they do not. As I have said before, I think this is an area that needs regulation, although how that can be done when often the material is published overseas is not easy to see.

But there is one thing that is certain. Any major Government contractor is vulnerable to changes in Government policy and financial retrenchment. Will the UK Government really be spending more on defence on future? I rather suspect not as other social priorities take precedence.

One of the Government’s priorities is to spend more on healthcare. There was a very interesting report on the activities of a company called Babylon Health in a recent BBC Horizon programme. Babylon, via their app called Babylon which anyone can download, provide an on-line symptom screening and G.P. service. This is an area I have taken an interest in for several years as it has always seemed to be that this is potentially one of the most effective uses of AI and medical technology to improve healthcare. Not that I have ever doubted the wisdom of doctors to diagnose my complex medical problems effectively but I do believe some intelligent assistance might speed diagnosis.

At present Babylon is focused on G.P. services although they are moving into more specialist secondary areas. In London they offer the service under the name “GP-at-hand” with support from the NHS. But some doctors are complaining they are pinching their registered patients which reduces their income in local surgeries, and leaves them with the relatively unhealthy and elderly who don’t have access to on-line services but are more expensive to service.

Babylon do not offer on-line diagnosis at present for legal reasons, which in my view is a pity. They just provide a “triage” service and pass you to a G.P. when required for an on-line video consultation. But would it not save the NHS an enormous amount of money to have patients doing their own diagnosis using an intelligent app? But the current “GP-at-hand” service is a step in the right direction.

Babylon have recently done a study of how their system compares to the diagnostic skills of real G.P.s and they came out of it well – see their report here: https://arxiv.org/pdf/1806.10698.pdf . For some more critical comments on the company and a summary of its history, see http://www.nhsforsale.info/private-providers/babylon-health.html . I fear G.P.s will resist this innovation because the NHS is notorious for its slow take up of technology. As the BBC programme reported, the NHS is now the biggest user of fax machines in the world when most organisations gave up using them years ago and turned to more direct digital channels. This is symptomatic of the NHS’s continuing reliance on paper processes.

Babylon is a British company but it is private equity funded and not a public company. But this is surely the kind of company than should be listed. It’s one of the best applications of AI. Undoubtedly I would have a lot more confidence in medical diagnostic software supported by a trained doctor than I have in self-driving cars. At least you can get a second opinion on the former before you crash.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )