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Not All Sin Stocks are Created Equal

Sin stocks.  Vice investments.  Merchants of death.  They all sound delightfully naughty, don’t they?

That’s because they are.  Based on the recent returns of alcohol and tobacco stocks, investors might conclude that it’s good to be bad.  In a year marked by macroeconomic shock waves emanating from Europe, popular sin stocks like more info Altria ($MO), Philip Morris International ($PM), Diageo ($DEO), and buy cheap generic viagra online canadian pharmacy Anheuser Busch InBev ($BUD) are all trading near 52-week highs. 

Over long investment time horizons, the story is much the same.  Vice investments tend to outperform the broader markets by a significant margin over the long haul.  In his eminently readable book The Future for Investors, Professor Jeremy Siegel found that the most profitable stock market investment in U.S. history was tobacco giant Altria—and this despite decades of falling tobacco usage among Americans and an endless string of punitive lawsuits.

Princeton Professor Harrison Hong and New York University professor Marcin Kacperczyk echoed these findings in their 2007 white paper canadian pharmacy no scripts The Price of Sin: The Effects of Social Norms on the Markets.  The professors found that the taboos associated with investing in politically incorrect industries such as tobacco, alcohol and gaming led these sectors to be priced as perpetual value stocks.  Many big institutional investors, such as pension funds and endowments, are prohibited from investing in these industries, which creates attractive pricing and dividend yields for investors with no such restrictions. 

Investors should keep in mind, however, that not all sin stocks are created equal.

Other than being collectively shunned by socially-responsible investors, the different categories of vice investments have very little in common.  Tobacco and alcohol are both considered defensive consumer staples, whereas gaming stocks are far more cyclical and dependent on the health of the travel and tourism industries. 

There is a reason why the Las Vegas casino stocks were not included in the list above of sin stocks making new 52-week highs.  MGM Resorts ($MGM), Wynn Resorts ($WYNN) and Las Vegas Sands ($LVS) have all suffered in recent years due to overcapacity and a tourist dearth.  Just this past week, the Nevada Gaming Control Board reported that the state’s gambling revenue fell sharply in May, the last month for which there was data.  Revenues on the Las Vegas Strip were down a full 18%.

But even within the alcohol and tobacco sphere—the “booze and butts”, if you will—the industry economics are very different.  Because of legal restrictions tobacco companies have very limited opportunities to advertise, whereas advertising and marketing are a major expense for spirits companies and are essential to the success of the brands.  Half of the pleasure of enjoying a nice scotch is the feeling of quality and exclusivity that the brand projects.  And who hasn’t seen the “most interesting man in the world” commercials and instantly wanted to drink a Dos Equis beer?

Implications for Investors

Sizemore Capital is a big believer in vice investing, and Altria and Diageo have been in our portfolios for multiple years.  Barring an irrational surge in their prices, these are stocks that I would be content to own forever, and they are a fine addition for any investor looking for current income.  But we do not currently have any positions in gaming stocks. 

The stable consistently that makes booze and butts stocks attractive is not present in the gambling industry.  This is not to say that gaming stocks cannot be profitably traded, and at the right price they could certainly be attractive.  But these are stocks that should be viewed as short-term trades rather than long-term dividend generators. 

Disclosures: Sizemore Capital is long MO and DEO in The Sizemore Investment Letter Portfolio.  This article first appeared on MarketWatch.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Visa and MasterCard: Underlying Macro Trends Still in Place

“Gimme what I need, uh, MasterCard or Vi-suh.”

From Wyclef Jean’s “Perfect Gentleman”

The U.S. consumer is in a bit of a pickle.  Jobs are not particularly easy to come by—the June jobs report showed unemployment sticking at 8.2% and only 80,000 new jobs created for the month—and the economy remains sluggish. 

True, the average American family carries less debt than they did a few year years ago, but their net worth hasn’t exactly grown much either. 

In short, the prognosis for the consumer is bleak. 

Retail stocks have held up relatively well, all things considered, though higher-end luxury retail has taken a beating.  Long-time Sizemore Investment Letter recommendation Coach ($COH) is down nearly 30% from its 2012 highs, and competitor Michael Kors ($KORS) is down by over 16%.  Investors fret that a slowing economy—and in particular slowing Chinese and emerging market economies—will lead to a disappointing string of quarters for purveyors of expensive discretionary purchases.

Yet amidst the bearishness towards bling, Visa ($V) and MasterCard ($MA) have been notable bright spots.  Visa is just 1-2 good trading days away from a new all-time high, and MasterCard is not far behind. 

There are a lot of high expectations built into the stock prices of both credit card companies.  Visa sells for 19 times trailing earnings and MasterCard for a lofty 27 times trailing earnings.  Forward estimates put the ratios at a more reasonable 17 and 16 times earnings, respectively, though both are well above the average for the S&P 500.

The optimism is not unwarranted.  Both companies are debt free. Visa enjoys mouth-watering operating and profit margins of 60% and 42%, respectively, and MasterCard’s profitability is only a hair’s breadth lower.   Both also enjoy returns on equity that would be the envy of any company outside of the technology sector.  In short, both companies deserve to trade at a premium to the broader market.

Still, with so much optimism baked into the stock price, a slight earnings miss by either could send shares tumbling in the short-term.  This is always the risk you run when buying a “hot” stock, and I would be wary of it as we enter earnings season.

Any sustained weakness should be viewed as a fantastic buying opportunity.  When I made Visa my pick in InvestorPlace’s 2011 “10 for 2011”stockpicking contest, I noted two durable macro trends that are still very much in place:

  1. The   transition to a global cashless society
  2. The rise of the emerging market consumer

The first point should be obvious.  Even in the United States, where credit and debit cards are ubiquitous, roughly 40% of all transactions are conducted with cash or paper checks.  Not all transactions will ever be captured with credit and debit cards, of course, but with internet commerce growing relative to “bricks and mortar,” you can bet that the percentage will grow. 

Consumers without access to traditional credit or banking services are embracing prepaid cards, branded with the Visa and MasterCard logos, and both companies are experimenting with ways to let consumers pay at retail cash registers using their mobile phones. 

This is a long way of saying that even if overall consumer spending growth is tepid, growth in electronic payments has plenty of room to grow.

The second point is the one I find the most promising, however.  Credit and debit card usage is soaring in virtually all major emerging markets as incomes rise and consumers join the ranks of the global middle class.  Both Visa and MasterCard stand to benefit from this trend, though Visa has the better presence globally.  Visa expects to get more than half of its revenues from overseas by 2015, and the overwhelming amount of this will come from emerging markets. 

Visa is what I call a classic “emerging markets lite” investment.  You get all the benefits of emerging markets growth but without the volatility and headache of investing in emerging markets directly.

Both Visa and MasterCard are due to report earnings within the next month.  I will be curious to see how the management of each addresses the effects of the economic slowdown in China and the rest of the developing world.

I suspect that, once the numbers are sorted, it will be clear that Chinese imports of iron ore and copper are in a protracted decline, but Chinese credit and debit card swiping are healthier than ever. 

In the meantime, I reiterate my recommendation to buy shares of both companies on any protracted weakness.

Disclosures: Sizemore Capital holds shares of Visa and Coach.

If you liked this article, consider getting Sizemore Insights via E-mail. 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Whiskey and Beer Better Long-Term Bets than Wine

It’s not often that a stock with a $5 billion market cap soars by over 20% in a single trading day, but such is the case for Constellation Brands ($STZ), the largest publically-traded wine merchant, and now the sole distributor in the United States of Corona and Grupo Modelo’s other Mexican beer brands.

Constellation was the unexpected winner in the Anheuser-Busch InBev ($BUD) – Grupo Modelo merger, as Constellation was able to buy out Bud’s 50% share of the companies’ Crown Imports joint venture for $1.8 billion.  Under the new deal, Constellation will have complete control of the distribution, marketing and pricing for all of Modelo’s brands in the United States, while AB InBev will act as supplier.

The deal is a major coup for Constellation—kudos to management for pulling it off—but the company remains one of my least favorite stocks in the alcohol and vice sphere for a one critical reason:

Wine is much harder to brand than beer or spirits.  Think about it; when you go to a bar, you can instantly recognize your favorite beer or whiskey on tap or behind the bar.  Outside of, say, Coca-Cola ($KO), beer and spirits are probably the most recognizable and valuable brand names in existence.  Not surprisingly, premium beer and spirits businesses tend to enjoy high margins and high returns on equity relative to their peers.

Stock

Ticker

Operating Marging

Return on Assets

Return on Equity

AB Inbev

BUD

30.19%

7.02%

16.12%

Diageo

DEO

26.12%

10.28%

41.07%

Constellation

STZ

18.33%

6.23%

17.02%

 

Wine is a different story.  The attractiveness of a given vineyard varies from year to year, and few have national or international brand awareness.  Wine connoisseurs know their favorite vintages, but there is little brand loyalty at the mass-market level.  For a company of Constellation’s size, wine is a much harder business to operate.

This is not to say that I dislike Constellation or would never consider owning it.  “Sin Stocks” are some of my favorite long-term holdings due to their defensive nature and due to their tendency to pay high dividends (Constellation currently pays no dividend), and an argument can be made for making room for Constellation in a diversified vice portfolio.  But I would definitely give a higher weighting to premium spirits groups such as Diageo ($DEO), Jim Beam ($BEAM) and Brown-Forman ($BF-B).

One last thing to note: the Crown Imports deal allows Constellation to get a significant chunk of its revenues and profits from the premium beer segment rather than wine.  This is good news.  But it’s also a source of concern due to a certain provision in the deal.  AB InBev has a “call option” of sorts to buy the Modelo brands back in 10 years at 13 times earnings before interest and taxes.  This price does not at all appear unreasonable, but if exercised Constellation will find itself as purely a wine merchant again.

Disclosures: DEO and BEAM are held in Sizemore Capital accounts.

If you liked this article, consider getting Sizemore Insights via E-mail. 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Turkcell: If I could be a Turkish general for a day…

Not to play on stereotypes, but if Turkcell ($TKC) were a government and not a private company, a cabal of stone-faced Turkish generals would have surrounded its headquarters with tanks months ago and forcibly taken over its board of directors.

And if they had, you could bet that the share price would have enjoyed a nice rally. The battle for control of Turkcell’s board—which has prevented the company from paying a dividend in over two years—has exhausted investor patience to the point that a coup d’état (or perhaps a coup de compagnie?) would seem appealing.

Investors may get their way, though alas, there will be no tanks. After a special shareholder meeting scheduled for June 29 failed to materialize, Turkish Transport Minister Binali Yildirim told Reuters that the government may soon intervene in the public interest.

The Turkish state certainly has the grounds to intervene. The Capital Markets Board, the Turkish markets regulator, warned Turkcell earlier in June that it had failed to comply with new rules requiring at least three independent board members. And why is Turkcell out of compliance? Because the two major shareholder factions can’t agree on who qualifies as an “independent” board member, and no one wants to give a vote to the “other guys.” Sigh….

For those new to this little bit of boardroom drama, two major shareholder groups are vying for control of the company, but neither currently has enough votes on the board of directors to prevail. The court cases that have ensued have spanned the globe, even ending up in locales as remote as the British Virgin Islands and Britain’s Privy Council.

The board drama has been a major distraction for the company and has impaired its long-term strategic planning, but it hasn’t slowed down the company’s operating results, which continue to be strong. Turkcell is widely praised for its Western-educated executive team and consistently ranks high among European peers for customer service quality. (Yes, you read that right. I said “European” and not “emerging market.” Turkcell punches above its weight.)

The proof is in the pudding. In the first quarter of 2012, Turkcell enjoyed year-over-year revenue growth of 12.3% and profit growth of 56.0% (see investor presentation).

Even better, the sales mix is shifting in Turkcell’s favor. The company enjoyed 35% year-over-year growth in smartphone sales, with the lucrative data plans that this implies, and the subscriber mix (which, like many emerging market providers, is weighted heavily towards pre-paid customers) continues its shift to post-paid contract customers.

Though the boardroom fiasco is no doubt keeping a lid on Turkcell’s share price, its moves have not been out of line with the broader Turkish market (see chart). Turkcell and the iShares MSCI Turkey ETF ($TUR) have moved in virtual lockstep since hitting a bottom in early June.

Turkcell remains one of my favorite plays on the rise of the emerging market consumer, and I consider the stock to be very attractively priced. Shares trade for just 10 times forward earnings, and the company has very little debt.

The board impasse will be broken—eventually. And when it is, investors can expect a modest dividend windfall.

Until then, they will have to be content with owning an emerging-market gem with great growth prospects trading at a modest earnings multiple. Come to think of it, that doesn’t sound so bad.

Disclosures: TKC is held in Sizemore Capital accounts.

If you liked this article, consider getting Sizemore Insights via E-mail

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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If I May Slander My Profession…

One of my favorite scenes in Martin Scorsese’s The Departed is the exchange where Jack Nicholson asks Leonardo DiCaprio what a nice kid like him was doing in the South Boston projects. “And if I can slander my own environment, it makes me sad, this regression.”

Unfortunately, I find myself asking the same question about my profession at times.  If I may slander my environment a little, it makes me sad to see people trust their financial security to the fickle whims of the stock market.  At best, it is a cold game of chance, and at worst—as the debacle of the Facebook ($FB) IPO showed—it’s a game that has been rigged against them.

To be sure, there are ways to mitigate the worst risks of stock market investing.  Never buy or sell on a “hot tip” unless you’ve done your homework first and have reason to trust the source.  Avoid microcap and penny stocks with anything other than your “play money.”  If you use an investment advisor or money manager, make sure they use a reputable third-party custodian, lest you fall victim to a Bernie Madoff-style Ponzi scheme.

Getting more into my areas of expertise, focus on dividends, though beware of chasing high dividend yields. Focusing on dividends and cash flows offers a degree of safety that a buy and hold (and pray) strategy can never offer, and you can realize a respectable cash return even in a down market.

But the best way to avoid taking unnecessary risk in the capital market is to refrain from putting your entire life savings into it.  Make sure that a significant chunk of your net worth and current income come from outside the traded markets.

This might sound like odd advice coming from a man who earns his living investing in the capital markets, but it is the only sound advice.

Think about it for a minute; what did your grandparents do?  Before the democratization of the stock market through mutual funds and 401k plans, people still invested their savings.  They still accumulated wealth, but they were more creative in how they invested it.

Let me throw out an example. My grandfather owned a small warehouse and shop floor in Fort Smith, Arkansas.  The rents generated from that property alone were sufficient to cover my grandmother’s modest retirement needs after he passed away.  He would have never left her financial security hanging on something as fragile as a 4% withdrawal rate from an index fund. (Ironically, given the theme of this article, his stock and bond portfolio ended up throwing off a lot more income than his warehouse, but he had no way to know that ahead of time.)

I’ve written before about rental houses as an investment (see “Here’s the catalyst for a housing rebound”), and I would like to reiterate that recommendation today. I know of no other legal investment that allows for both tax free current income (technically “tax deferred” for you accountants out there) and capital appreciation that will likely at least keep pace with inflation and allows you to do it all with borrowed money.

Yes, I know.  Home prices are falling.  Americans are broke.  There’s an enormous backlog of foreclosed properties that have to be worked off.  All of this is true.

But it is also true that new construction has been close to nil in recent years even while the population has grown and that mortgage rates—even for rentals—are at low levels most of us never dreamed possible.  Nationally, the price-to-rent ratio has fallen to levels not seen in well over a decade, and in many markets it is far cheaper to buy than rent.

On balance, it would seem that flattish prices would be more likely than large declines in most areas, but that is not really the point.  I’m not recommending you buy-and-hold the Case-Shiller Housing Index (sadly, there were ETFs to track this for a while; thankfully, they folded).  I recommending you put on a good pair of walking shoes and that you look around for a handful of rental properties that you can reasonably expect to rent out at a profit after allowing for debt service and expenses.

To clarify, I’m not recommending you quit the stock market altogether.  There is money to be made for those with the patience and emotional temperament for it, and stocks—like rental real estate—can be fantastic generators of cash income.

But they shouldn’t be the only asset you own, and you shouldn’t bet your retirement on capital gains that may never come.

If you liked this article, consider getting Sizemore Insights via E-mail.  This article first appeared on MarketWatch.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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