Tag Archives | Big Tobacco

Big Tobacco Launches a “Safer” Cigarette. It Won’t Stem the Decline

You have to hand it to Big Tobacco.  As an industry, it’s a survivor.  It’s doing everything it can to reinvent itself in a world in which its core product—cigarettes—becomes more of a social pariah with every passing year.  Let’s take a look at what Big Tobacco is up to and what it might mean for investors in Big Tobacco stocks.

Reynolds American (RAI) made headlines this week by announcing the planned launch of the Revo, a “safe” cigarette that heats tobacco rather than burning it. Philip Morris International (PM) has a similar product in the works for sale overseas, which I highlighted earlier this year.

Yogi Berra, the Hall-of-Fame  New York Yankee catcher, might have called this a case of déjà vu all over again. Reynolds American launched a similar product two decades ago, but it never amounted to much. (Yogi Berra, incidentally, was once a celebrity endorser of Camel cigarettes, a Reynolds American brand.)

E-cigarettes work in roughly the same way. Tobacco is heated rather than burned, and the smoker inhales a relatively harmless nicotine-infused vapor rather than a cloud of carcinogenic smoke. The benefit of the Revo is that it looks and feels more like a real cigarette than its electronic competitors do. And while it’s far too early to be breaking down profitability, I think it’s safe to say that Revo is a better profit model for Big Tobacco. Revo is a real, branded cigarette sold in a pack that can be sold at a premium, not a generic bottle of refill fluid.

I’ve been skeptical of e-cigarettes for a long time. Yes, they could relight Big Tobacco’s prospects. But they are just as likely to speed the decline of traditional cigarettes, and Big Tobacco has no durable competitive advantage in the e-cigarette marketing free-for-all.

So, are Revo and its competitors the answer for Big Tobacco?

Not so fast.  One of the reasons that Revo’s predecessor failed was that multiple states sued Reynolds American for claiming that it was less harmful than a traditional cigarette.  Those claims were unsubstantiated by real studies. So, Reynolds will have to be careful in how it markets Revo this time around the wrath of regulators.  But neutering the marketing will make it a lot harder to build a following among smokers.

In a best case scenario, Revo might steal a little market share from traditional cigarettes and slow down the long-term decline of the industry.  But that is the best case, and even under this scenario Big Tobacco volume sales would continue to decline.  The more likely scenario is that Revo is a marketing flop that is forgotten in a year or two.

From the tone of this article, you might think that I’m a dyed-in-the-wool Big Tobacco bear. Nothing could be further from the truth. At the right price, industries in terminal decline can be great investments if management focuses on returning value to shareholders via dividends and buybacks. But the key is “at the right price.”  And right now, Big Tobacco stocks are expensive.

Reynolds American trades for 21.5 times trailing 12-month earnings…and at a cyclically-adjusted price/earnings ratio (the “CAPE” or “Shiller P/E”) of 26.0 times earnings.  The numbers for domestic rival Altria (MO)  are 22.5 and 24.3, respectively.  As a point of reference, the S&P 500 trades at 20.0 times trailing earnings and 26.6 times CAPE—a valuation that is 60.2% above its long-term average.

In other words, U.S. stocks are very expensive by historical standards, and Big Tobacco stocks are only a hair cheaper that the broader market.  And again, this is an industry in terminal decline—which should be trading at a substantial discount to the market average.

In the interests of full disclosure, I have very small positions in Altria and Philip Morris International that I have held for years in a long-term dividend reinvestment portfolio.  But I’m not adding any new funds to either, and I recommend steering clear of Big Tobacco at current prices.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Lorillard is a Bad Deal for Reynolds American Investors

And then there were two.  Two of the three remaining American “Big Tobacco” companies announced today that they would be merging: Reynolds American (RAI) will be buying Lorillard (LO) for $27.4 billion, including debt assumed.

Reynolds and Lorillard combined have sales of $13.3 billion and a market cap of $55.3 billion as of yesterday’s prices, leaving Altria (MO), the maker of Marlboro and other iconic brands in the number one spot.  Altria has annual revenues of $17.7 billion and sports a market cap of $84.5 billion.  Breaking it out by market share, the new Reynolds will control about 42% of the U.S. cigarette market, Altria will control about 51%, and smaller and foreign brands will make up the rest.

I’ll be brutally frank here: I question the value of this merger.  Reynolds is paying a high price for what is, we should remember, a business in terminal decline.  As of yesterday’s close, Lorillard shares traded for 21 times earnings and at a dividend yield of only 3.8%—quite low by the standards of a tobacco company.

Let me be clear on something: I’m not necessarily opposed to buying stocks in industries that are in terminal decline.  Under the right set of conditions—barriers to new competitors, dominant market position, minimal need for new capital investment, ample cash flows for dividends and buybacks, etc.—stocks with shrinking businesses can be excellent investments.

But the key here is price.  An investment in a shrinking company only makes sense if it is priced at a deep discount to the broader market.  And Lorillard—as implausible as this is—trades at a slight premium to the S&P 500.

Forgetting price for a moment, the Lorillard deal also brings with it regulatory risk.  85% of Lorillard’s sales come from its menthol brands, and these have become a lightning rod in recent years.  The U.S. Food and Drug Administration has already banned most flavored cigarettes and reported last year that it believes menthol cigarettes contribute to youth smoking.

Reynolds is effectively making a $27.4 billion bet that the FDA will leave menthol cigarettes alone.  That seems reckless to me; it’s a bet with modest upside and potentially disastrous downside.

Is there a trade to make here?

Yes: Sell Reynolds if you own it and move on.

I’m not the biggest fan of tobacco stocks at current prices.  I have shares of Altria and Philip Morris International (PM) that I have owned for years as part of a dividend reinvestment strategy, but I haven’t invested any significant new money in these positions in years because I see better income options elsewhere, such as in REITs.

If you feel you must own tobacco stocks, then I would go with Altria or Philip Morris International.  While neither are fantastic bargains these days, neither have the potential regulatory time bomb that Reynolds does in its exposure to menthol.  At time of writing, MO and PM sport dividend yields of 4.5% and 4.1%, in line with RAI’s 4.3%.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

 

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It Just Keeps Getting Worse For Big Tobacco

The bad news just doesn’t stop for Big Tobacco.  The industry is no stranger to smoking bans, punitive taxation, and crippling lawsuits, particularly in the United States.  But life continues to get more difficult in much of the rest of the developed world too.  Let’s take a look at new developments coming out of the UK.

In June, the British Medical Association (“BMA”) voted in favor of banning cigarette sales to anyone born after 2000. The BMA is a doctors’ union, not an arm of the government, so its proposed ban has no legal teeth to it.  But this is the same BMA that successfully lobbied the British government to ban smoking in public places.  The UK’s Health Act of 2006, supported by the BMA, made smoking illegal in all government buildings, workplaces, and restaurants.

Whether the ban on British would-be future smokers passes or not, the handwriting is on the wall.  Western governments, saddled with unaffordable health costs, will not be letting up the pressure on Big Tobacco any time soon. And it’s starting to show up in earnings reports.  Last week, Philip Morris International (PM)  trimmed its earnings outlook for 2014, citing, among other factors, one of the most potentially devastating regulatory developments in decades: Australia’s plain packaging rules, which require all cigarettes, regardless of brand, to be sold in plain, white boxes with standardized font on one side…and a picture of a person dying of cancer on the other.

I wrote about Australia’s new rules a year ago (see “Judge Tobacco Stocks by Their Cover”), predicting that they would be very damaging to Big Tobacco’s branding power.  As I wrote then,

Longtime chain smokers light up for one very obvious reason: They are addicted to the nicotine. But for casual smokers — those who light up while drinking, for example — the experience matters, too.

I call it the “Rebel Without a Cause effect” … the devil-may-care image that goes along with smoking is part of what makes it pleasurable.

There is a certain appeal to Altria’s (MO) familiar Marlboro logo. But there is most certainly no romance in a plain white box with a picture of a diseased lung on the flip-side.

 Sure enough, Philip Morris CEO Andre Calantzopoulos noted that the rules were having an ill effect on Australian sales:  “With plain packaging, adult smokers do not quit more or smoke less. They do, however, appear to down-trade much more readily to lower price, lower margin brands and illicit products.”

The UK and Ireland are also seriously considering plain packaging laws, and several other countries are reported to at least be toying with the idea.

Even “vaping,” or the smoking of e-cigarettes, is under attack.  The U.S. Food and Drug Administration announced in April that it would be begin regulating electronic cigarettes.  And overseas, Britain’s equivalent of the FDA will begin regulating e-cigs as of 2016.  E-cigarettes—which are safer than traditional cigarettes because of the absence of carcinogenic tar—are actually illegal in Brazil, Norway and Singapore.

Remember, e-cigs were supposed to “relight” Big Tobacco as the transformative product that saved the industry from secular decline.  So much for that idea.

Where does Big Tobacco go from here?

I’m not predicting wholesale bankruptcy any time soon, and in fact, I still own shares of PM and  MO in a few dividend-focused portfolios I run. But I believe it’s important to be realistic here.  The industry’s ace in the hole—rising demand overseas to offset long-term decline in the developed world—is looking less and less reliable.  Even China—the world’s largest tobacco user by a wide margin—moved to ban indoor public smoking earlier this year.  It is only a matter of time before the regulatory vice is tightened further.

If you own tobacco stocks as part of a diversified dividend portfolio, I think it’s fine to continue holding your positions and to reinvest the dividends.  But I wouldn’t put significant new money into Big Tobacco any time soon, or at least not at today’s prices.  PM and MO trade for 16 and 19 times earnings, respectively, compared to an P/E of about 20 for the S&P 500.  Given the lousy growth prospects and the virtual guarantee of continued regulatory attacks, I would only recommend making new purchases of Big Tobacco stocks at much wider discounts to the market.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Will “Safer” Cigarettes Save Big Tobacco Stocks?

Philip Morris International (PM) recently announced plans for a $680 million factory in Italy to produce less-lethal cigarettes.

Notice I said “less-lethal” and not “nonlethal.” Unlike the popular new e-cigarettes, which produce a nicotine vapor mist, the Philip Morris variety will contain real tobacco to appeal to smokers who crave the taste of a real cigarette. Though unlike with traditional smokes, the tobacco is heated rather than burned.

So, is this a big deal? Might Philip Morris’ efforts stem the terminal decline of smoking in the developed world?

Maybe … but I’m not buying it.

We’ve seen this before. In fact, Jeff Middleswart wrote about this very topic in Behind the Numbers this week. Writing about Reynolds America (RAI), Middleswart noted that:

“In 2000, RJ Reynolds rolled out the Eclipse cigarette, which was designed to heat the tobacco rather than burn it. The result was much less smoke and in advertising it claimed that was less harmful than other cigarettes. Studies did not substantiate that and states started to sue over the claims. RAI just paid Vermont $14 million to settle these claims.”

Oops.

Throughout 2013, I made the argument that tobacco stocks no longer represented an attractive investment on a value basis. I maintain two long-term positions in PM stock and Altria (MO) in a dividend-focused portfolio, but I don’t recommend adding new money to those positions at current prices.

Big Tobacco isn’t disappearing any time soon. It’s still a wildly profitable business, and tobacco stocks are some of the most reliable dividend payers traded on the market today. But anyone expecting tobacco stocks to deliver market-beating returns going forward needs to take a step back and look at the numbers.

Thankfully, Middleswart has done the heavy lifting for us. Writing again about Reynolds American in his Jan. 9 issue, Middleswart commented that Reynolds traded at a 7.6% yield in September 2002 and at a P/E ratio of just 40% of the broad market.

And today? Reynolds yields 5.2% and sports a P/E that is 90% of the broad market, roughly in line with its peers.

If you’re buying Big Tobacco stocks at current prices, then you are implicitly assuming that one or both of the following must be true:

  1. U.S. stocks — which are already looking expensive based on the cyclically adjusted P/E ratio (CAPE) — will command a significantly higher valuation than they do today.
  2. Tobacco stocks will trade at a substantial premium to the broader market.

Do either of these scenarios seem likely to you?

Again, I’m not a permabear on tobacco stocks. At this right price, I love tobacco stocks as consistent dividend payers.

But that’s the key; the price needs to be right. Tobacco stocks should trade at a substantial discount to the broader market given that they are in terminal (albeit slow) decline.

But what about e-cigarettes? Might they offer a source of new growth for the battered industry?

Yes, and in fact, they already are. But the e-cig market is not big enough to replace declining sales of traditional cigarettes. As I wrote last year, the era of regulation-free e-cigs is quickly coming to an end, and in any event, e-cigarettes only account for about 1% of total tobacco sales.

If you insist in owning tobacco stocks, then PM stock and Altria are easily the “cleanest dirty shirts” of the lot. Philip Morris International’s emerging-market business has a much longer shelf life than those of the domestic sellers, and Altria owns nearly 30% of SAB Miller (SBMRY), the diversified global brewer.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends. This article first appeared on InvestorPlace.

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Is the E-Cigarette Revolution Getting Stubbed Out?

Earlier this year, I asked if e-cigarettes would relight Big Tobacco’s prospects. My answer was an unequivocal “no.”

Rather than being a durable growth business for Altria (MO), Reynolds American (RAI) or Lorillard (LO), e-cigarettes seem to be yet another way to help people stop smoking—a trendier version of a nicotine patch or Nicorette gum, if you will. And because, as non-tobacco products, e-cigs were almost completely unregulated, they eroded another long-term competitive advantage for the existing players in the industry: high barriers to entry.

Outside of weapons, tobacco is probably the most regulated industry on the planet. An onerous regulatory regime favors large existing players with the size and political influence to navigate the red tape and has the effect of snuffing out smaller players and would-be upstarts. This is one of the reasons that, despite decades of punitive taxes and lawsuits and an ever-shrinking customer base, Big Tobacco is still wildly profitable. (In the special case of tobacco, the ban on advertising also give established brands with name recognition an insurmountable advantage over would-be upstarts.)

But in the wild-wild-west world of unregulated e-cigs, there are over 250 brands currently on the market and little or no restrictions on their sale or advertising. And in a shocking marketing failure for companies that are normally run like well-oiled machines, Big Tobacco largely botched the e-cig branding game.  As I wrote in June, Altria, the maker of the iconic Marlboro brand (among others) launched its new e-cig under the brand name Mark Ten.  Take a look at the brand’s website. There is no mention of Altria, Philip Morris, or Marlboro.

The unregulated free-for-all may be quickly coming to an end. The attorneys general for 37 states, Puerto Rico, Guam and the U.S. Virgin Islands have petitioned the U.S. Food and Drug Administration to regulate e-cigs as if they were tobacco products. Among their concerns are the attractiveness of e-cigs—some of which are fruit flavored like a hookah water pipe—to children and teenagers.  According to the Center for Disease Control, 1 in 10 high school students tried an e-cig in 2012.

And it’s not just American authorities.  On October 8, the European Parliament is expected to vote on a new tobacco directive that would treat e-cigs as a medicine and subject them to strict regulation.

We should have seen this coming. Call it an adaptation of Maslow’s Hammer: If all you have is a hammer, everything looks like a nail. After four decades of aggressively attacking tobacco smoking as a social ill, it its natural that regulators will clamp down on something that “looks like tobacco,” even if it is smokeless and likely no more harmful than my (admittedly excessive) coffee habit.

What does this mean for the industry?

Ironically, it’s modestly good news for Big Tobacco. Regulation should slow down the trend of smokers ditching their cigarettes for e-cigs. And within the e-cig universe, Big Tobacco will have a massive advantage over smaller upstarts. Altria knows a thing or two about navigating rough regulatory seas.  They can transfer that knowledge to their Mark Ten e-cig brand far more easily than a new upstart brand can learn it.

We need to keep a little perspective though. E-cigs still only make up about 1% of traditional cigarette sales, and cigarette sales continue to sink lower.  To the extent that tobacco is investable, it is a no-growth dividend and share buyback story. Tobacco is not—and never will be again—a growth story.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long MO. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”  This article first appeared on InvestorPlace.

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