If you want a group of companies that can perform well in good times and bad, you don’t have to look much further than vice stocks.
If you’re comfortable making money off addictive industries, alcohol, casinos and tobacco firms can show a level of returns you can’t find anywhere else. For instance, over the past 10 years, the USA Mutuals’ Barrier Fund (ticker: VICEX), which only invests in sin stocks, has risen 8.43 percent, beating the Standard & Poor’s 500 index’s 8.03 percent annual returns.
Within that group, tobacco companies have recently lit up, rising 16 percent in the past six months alone. The jump is almost counter to what you might expect, since fewer people are smoking. From 2005 to 2013, the number of smokers in the U.S. dropped from 21 percent to 18 percent, but stock of Altria Group (MO), Philip Morris International (PM) and the like continue to rise.
What’s driving this move forward by Big Tobacco? And can it last?
Countering the decline in numbers. Altria, which only targets U.S. smokers, has seen shipment volumes of cigarettes fall 7 percent in the past two years. Philip Morris, which only sells in markets outside the U.S., has seen a similar trend.
But revenues, particularly from Altria, continue to rise. Through nine months of 2015, Altria’s revenues increased 5.5 percent compared to the previous year because it countered the fall in shipment volume by increasing the price of its products. This tactic, which allows Altria to grow revenue despite lagging cigarette sales, has coincided with improved consumer spending and cheap gas prices.
“The benefit from gas prices kicked in about a year ago,” says Michael Lavery, analyst at CLSA Equity Research in New York. “And they’re not grinding to halt just yet.”
Since cheap oil has led to a 28 percent decline in gas prices nationally, consumers who customarily buy cigarettes as they fill up the car have a little more money to spend for their nicotine habit.
Lavery doesn’t believe this gas trend will continue, but since tobacco is addictive, sales are expected to stick. Proof is found in the long-term results of the industry. Credit Suisse looked at the returns of all industries from 1900 to 2014 and found tobacco performed the best, with an annual return of 14.6 percent.
The e-cigarette trend. The e-cigarette craze is a relatively new development for tobacco companies. While it’s only a minor threat at the time, vapor devices could prove the greatest challenge to tobacco companies long term. Research firm Euromonitor pegs the size of the cigarette sales worldwide at $744 billion, while e-cigarettes come at a mediocre $6.5 billion. E-cigarettes are “currently not a competitor,” says Euromonitor researcher Shane MacGuill.
However, it’s impossible not to ignore the appeal of the e-cigarette offering, as it’s less smelly and, potentially, less dangerous. If a larger percentage of the industry begins to move to e-cigarettes, the current margins would change. The cost to create one e-cigarette is higher than that of a regular cigarette, which could make “a huge difference in profit margins,” MacGuill says.
Companies have already started to prepare for this potential future. Nearly all the major cigarette companies own some stake in e-cigarettes “to learn about the business model,” MacGuill says.
Regulation, taxes and plain packaging laws. The other potential impact for cigarette companies is regulation and taxes in established markets, such as the U.K. and the U.S. Next year, the U.K. will begin enforcing plain packaging laws, which will remove all advertisements and marketing from cigarette packs in England. This could have a drastic impact on sales, and Philip Morris and British American Tobacco have sued the British government over the passage of the law.
Australia took a similar step in 2012. Since then, Australia has seen very little change in the number of smokers. Instead, these efforts hurt the tobacco companies’ ability to raise prices, offer premium products or market innovations. If companies want to feature new offerings, they “can’t communicate those to consumers,” MacGuill says.
It will be more difficult for tobacco companies to charge premium prices for products if they can’t tell consumers why one is more expensive than another.
Emerging markets have causes for concern. Emerging markets remain the growth engine for many tobacco firms. With fewer restrictions and taxes, prices can remain low. Meanwhile, many of the governments in the region don’t share anti-tobacco information. This allows companies to function with more ease.
But similar issues to the U.S. have impacted emerging markets. Indonesia, with a population of 250 million, has seen annual cigarette volume growth rates decline from 6 to 8 percent to 1 to 3 percent, Lavery says. To counter this trend, cigarette companies have turned to the same strategy that they have in America: raise prices.
“Pricing can still drive revenue growth” in emerging countries, Lavery says, if the trend of income development continues in the regions. If the economies suffer, then tobacco companies’ efforts would likely reverse.
Cigarettes are still addictive. Despite all of this, the addictive nature of tobacco will continue to drive sales. The number of global cigarette smokers grew from 721 million to 967 million from 1980 to 2012, according to the Journal of American Medical Association, and the number of cigarettes consumed increased from 4.96 trillion to 6.25 trillion in that period. So even if the percentage of cigarette users declines, the globe’s rapidly growing population will still provide plenty of customers for tobacco companies.
“With the sheer scale of the numbers, [investors have] quite a reasonable cause for optimism in the short-to-medium term,” MacGuill says.
It’s the durability of the sin stock. They remain profitable, until something better comes along.nu
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5 Things to Know Before Investing in Big Tobacco Stocks originally appeared on usnews.com
