Tag Archives | Big Tobacco

My Favorite Tobacco Stock is…Intel?

Yes, you read that correctly.  My favorite “tobacco stock” is Intel Corp (Nasdaq:$INTC).

Lest you think I’ve lost my mind, I am aware that Intel does not sell or market cigarettes or other tobacco products. Intel is the world’s premier designer and manufacturer of computer processors.

But while Intel is not a tobacco company, it most certainly is a tobacco stock, or at least it shares many of their characteristics.

This requires a little explaining.  If you’ve read some of my past posts, you are probably familiar with my reasons for liking tobacco stocks over the long haul, even if I recommend avoiding them at current prices (see The Price of Sin and Time to Stop Bogarting Cigarette Stocks).  Because of the social stigma associated with vice investments like tobacco, alcohol and firearms, many institutional investors shun them, either by choice or by socially-responsible investment mandate.  This causes sin stocks to be priced as perpetual value stocks, with the low valuations and fat dividends that this entails.

Well, I admit, in this particular respect Intel has nothing in common with tobacco stocks (even if it is priced like one at the moment).  It’s hard to find a scale by which Intel would be considered socially irresponsible. But let’s take a look at some of the other characteristics that make tobacco stocks—and Intel—interesting.

Tobacco companies have gargantuan barriers to new competition—what Warren Buffett might call an unassailable moat.   Given the legal and political risk and the size and scale needed to deal with both, it would be next to impossible to start a new tobacco company now.  You would need infinitely deep pockets and decades’ worth of political connections. As a result, Big Tobacco has become an entrenched oligopoly in which a handful of players—such as Altria (NYSE: $MO), Reynolds American (NYSE:$RAI) and Lorillard (NYSE:$LO)—completely dominate.

But even if you could start a new tobacco company, why would you?  It’s not exactly a business with a bright future.  In the developed world, tobacco is a business in steady but terminal decline.

This brings me back to Intel.  I’m actually in the minority among investors at the moment in that I see a bright future for Intel.  No, they haven’t figured out mobile yet, but they will.  As mobile devices become more and more sophisticated, they will need the power than only Intel can provide.  And there is also the server business, which accounts for roughly a quarter of Intel’s revenues.  Ironically, while Intel has yet to really break into mobile, its server business has benefitted handsomely as the mobile revolution has created greater demand for cloud services.

Yet this is not how the market views Intel right now.  No, Intel is a company resigned to gentle decline, as its core PC market inevitably shrinks.  From the way Intel bears talk, PC users are disappearing from polite company faster than smokers, forced to type on their physical keyboards in alleys behind buildings or in doorways.

For the sake of argument, let’s assume they’re right.  Intel would still be a buy at current prices.

As the Big Tobacco has proven for decades, companies in declining industries can make excellent investments under the right conditions.  If you have a dominant market position (think back to Warren Buffett’s “moats”), a conservative balance sheet, and have ample cash flow for share repurchases and dividends, you can do quite well by your investors even in a shrinking market. It’s worked for Big Tobacco investors, and it will work for Intel investors as well.

At just 9 times earnings, Intel is priced significantly cheaper than any major tobacco stock, and its dividend is competitive at 4.3%.  I might add that Intel’s dividend has risen by over 40% in the past two years and that its dividend still only accounts for 37% of (depressed) earnings.

Buy Intel and reinvest your dividends.  If I am right, Intel will regain its place among America’s most reputable growth stocks.  But even if I’m wrong, Intel is positioned to offer “tobacco like” returns for the foreseeable future.

Note: The “Intel is a tobacco stock” concept was conceived during a podcast interview with InvestorPlace Editor Jeff Reeves in which we each discussed our picks in the 10 Best Stocks of 2013 contest.  Jeff’s choice was Intel; mine was German luxury carmaker Daimler (OTC:DDAIF).

Disclosures: Sizemore Capital is long INTC and DDAIF

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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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It’s Time to Stop Bogarting Cigarette Stocks

You know you have reached a certain level of immortality when your name becomes a verb, and I can think of no better example than the American actor Humphrey Bogart, perhaps best known for his role in that all-time classic Casablanca.

“To Bogart” a cigarette is to leave it dangling sloppily in your mouth, even when speaking, rather than engaging in proper smoking etiquette by giving it a few puffs at a time and then removing it.  Over the years, the word has also come to mean to greedily hog something.

Today, I would say both meanings of the word are accurate descriptions of investors in tobacco stocks.   Investors  are “Bogarting” cigarette stocks by continuing to hold them at current prices.

First, a little disclosure is needed.  I have been a major fan of sin stocks in general and cigarette stocks in particular for years (seeNot All Sin Stocks are Created Equal and Delightfully Sinful Dividend Stocks as recent examples.

But my enthusiasm for Big Tobacco rested on two big assumptions:

  1. They are largely despised by both individual and institutional investors due to their pariah status as politically incorrect merchants of death—making them perpetual contrarian value investments.
  2. They pay high and growing dividends that are significantly better than what can be found elsewhere among mainstream large-cap stocks.

Unfortunately, I cannot credibly say that either of these conditions still hold.  Cigarette stocks have become downright trendy of late as investors have taken to chasing yield in a low-interest-rate world.

Let’s take a look at Philip Morris International (NYSE:$PM), the seller of the iconic Marlboro brand among many others.

For years Philip Morris appeared to be the perfect stock.  It had access to emerging market growth (roughly half its sales) while benefitting from an American listing and top-notch management.   It also paid a dividend far higher than the norm among stable U.S. blue-chip stocks, and that dividend was growing every year.

There’s one little problem here:  Philip Morris International is still a tobacco company.  Its sales may be enjoying a multi-year boost as emerging market smokers trade up from cheaper local competitors to premium Western cigarettes, but worldwide demand for their products is shrinking, and fast.

In its most recent quarterly release, Philip Morris International saw its profits fall 6% on lower volume sales.

And perhaps worse, the regulatory noose continues to be tightened.  Consider Australia’s new plain packaging law.  All cigarette boxes for all brands now look identical in Australia.  Cigarettes must now be sold in logo-free boxes featuring nothing more than graphic pictures of people dying of smoke-related illness.  It’s hard to enjoy taking a drag on that cigarette when you’re looking at a picture of a gangrenous foot on the package.

This does not at all bode well for premium brands like Marlboro.  Given that tobacco companies are all but prohibited from advertising, how can a premium brand differentiate itself from the cheaper competition when it sells its cigarettes in an identical box?

Australia has adopted the most aggressively anti-tobacco regime in the world in taking this approach, but other countries are catching up in a hurry.   Russia, the world’s second-largest tobacco market after China, is starting to take tobacco’s health risks seriously.  Russian prime minister Dmitry Medvedev recently said that a ban on public smoking and cigarette advertising t were “just the beginning” of his efforts to stamp out cigarette smoking in his country. Several countries in Latin America have joined this bandwagon as well.

Meanwhile, Philip Morris International’s dividend yield, now 3.9%, is not the great selling point it used to be.  It’s lower than that of the 4.2% offered by blue chip semiconductor maker Intel (Nasdaq:$INTC) and significantly lower than that of most telecom stocks, MLPs and REITs.

Again, unlike the rest of these industries—which are still growing—Philip Morris faces a shrinking market for its wares.  And its stock valuation of 17 times is ludicrous given that Intel trades for just 9 times earnings.

Taking a look at other Big Tobacco giants, the story isn’t much better.  I have a special fondness for Lorillard (NYSE:$LO) because it was one of my most successful trades in history.  I made 40% in all of two weeks (see “Insider Edge in Practice: Lorillard”).

But I wouldn’t be particularly enthusiastic about buying Lorillard today.  Based on current earnings, it actually trades at a slight premium to the broader S&P 500.   Yes, the juicy 5.3% dividend is appealing.  But Lorillard is still a cigarette company selling primarily to a shrinking U.S. market, and it’s hard to justify buying it at a premium P/E ratio.

The same is true of Reynolds American (NYSE:$RAI) and Altria (NYSE:$MO), the granddaddy of all Big Tobacco stocks.    Reynolds trades for a ridiculous 17 times earnings and Altria trades for 15.  Both enjoy yields over 5%.  (In the interests of full disclosure, MO is currently rated a “Hold” in the Sizemore Investment Letter; it’s been a holding of the portfolio for two years, and I’ve been reluctant to pull the trigger and sell because of the taxable gains it would generate.  But I have tightened my stops in MO and am not advising that investors put new money into it.)

Investors have enjoyed a fantastic ride in Big Tobacco stocks, but like a good cigarette (or cigar if you prefer), they will eventually burn out.  This long-time tobacco bull recommends discarding Philip Morris International like a soggy cigarette butt and viewing the rest of the sector with skepticism.  There are better income opportunities elsewhere.

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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