“Cigars must be smoked one at a time, peaceably, with all the leisure in the world. Cigarettes are of the instant, Cigars are for eternity.” - Guillermo Cabrera Infante

On August 29, 2023, Scandinavian Tobacco Group released its Q2 results. Total net sales were down -2.3% y/y, group EBITDA margin was down 80bps, and adjusted EPS was down to 3.5DKK from 3.6DKK last year. Additionally, new store openings in the U.S. have been delayed, FX rates negatively impacted results, and full-year guidance has been revised marginally lower. Catastrophic? Not quite. Alongside these less-than-stellar headline results are a number of notable points that further support the long-term thesis laid out in July. STG remains a relatively small company, listed in an overlooked market, operating in an ignored subsegment of an unpopular industry. Yet it holds an impressive portfolio of assets, is highly cash-generative, and is likely to continue consolidating the field while management remains extremely shareholder-friendly.

In Q2 2023, Europe Branded net sales, predominantly machine-made cigars, declined by -1%. To add, market volume was down ~3%, above the historical decline rate, with STG’s share down for the quarter to 29.8%, from 30.7% in Q1. Across most countries, pricing more than offset volume declines and—along with portfolio simplification—should support net sales and lead to margin expansion throughout the rest of the year. The loss of share stems from continued strength in flavored products, a challenge to STG, which is the leader in non-flavored variants. A pertinent exchange was shared during the Q&A of the quarterly call:

Additionally, the group’s next-gen products—including STRÖM and !act—are included in this segment. These products are still experimental, being tried in various small markets, and evaluated for further development and introduction. With this in mind, core product performance in the segment has been more resilient than it first appears.

Like Europe Branded, NA Branded & Rest of World faced considerable challenges in Q2. Sales declined by -6%, largely the result of declining volumes of handmade cigars on the back of restocking patterns in the U.S., which was partly offset by the acquisition of Alec Bradley. Further weakness in EBITDA came from lower contract manufacturing sales, as well as persistent cost inflation. To compound, while the acquisition of Alec Bradley helped bolster net sales to a degree, STG has been forced to reinvest in the brand at a higher rate, as CEO Niels Frederiksen humbly conceded during the call:

"There's no doubt that Alec Bradley is also impacted by the inventory readjustment. And there's also -- when we took over Alec Bradley, we took over a brand that was performing well but also one that, to be honest, during the acquisition had not been maintaining an innovation pipeline. So we have had to invest more resources in, let's say, reestablishing an assortment of innovation required to compete in the market. So we're not super nervous about this, although it's always not what you would optimally want to find. What we do and what we have been encouraged by is when you look at our Alec Bradley's performance in our online channel what we have, then we are delivering growth year-on-year on Alec Bradley."

There is little concern about a longer timeline as STG is executing the exact playbook that has worked exceptionally for past deals. The growth of Alec Bradley in the online channel is also least surprising, as STG-owned websites, such as CIGAR.com, have continually run targetted promotions since finalizing the acquisition, as well as limited-time email promotions to their verified customer emails:

Alec Bradley is far from the only bright spot in STG’s Online & Retail presence. In fact, while Europe Branded and NA Branded & Rest of World declined in Q2, NA Online & Retail saw growth across both e-commerce and brick-and-mortar, with net sales increasing 3% y/y. As noted previously, Covid lockdowns led to a massive uptick in Online sales, which was followed by an unsurprising reversal as the U.S. reopened. Now, strength across the category shows that the number of active online customers stabilizing, as well as the...