Tag Archives | sin stocks

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.

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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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Philip Morris International: A Dividend Stock Best Avoided

Nothing is more detrimental to the long-term viability of an investment theme than its own success.  In the often circular logic that defines the market, profitable trades can only remain so as long as they are unpopular.  Once they are embraced by the investing public, prices have generally risen to a point that would make the trade unattractive to its original value-focused adherents.

It is thus with great sadness that I must recommend readers sell their shares of Philip Morris International (NYSE: $PM).  At current prices, this is a dividend stock best avoided.

When Altria (NYSE:$MO) spun off its international tobacco businesses and formed Philip Morris International in 2008, it was about as close as you could get to the perfect stock.  You had all of the standard bullish arguments for tobacco—recession-resistant demand, an addicted customer base, low marketing costs, high cash flows, etc.—but without the threat of crippling lawsuits from the U.S. tort system.

Philip Morris International was also uniquely positioned to take advantage of rising incomes in the developed world.  As consumers in key emerging markets such as China traded up from lower-quality domestic brands, the maker of Marlboro was uniquely positioned to benefit, and still is.

And finally—and perhaps most importantly—Philip Morris International was a dividend-producing powerhouse at a time when decent yields were hard to come by. 

It was the convergence of all of my favorite investment themes in one stock: a high-dividend sin stock with emerging market growth and brand cachet!

But no matter how great an investment looks, your long-term success is ultimately dependent on the price you pay.  And the reason that tobacco stocks have been such great wealth-creation vehicles in recent decades is because they have been perpetually priced as high-dividend value stocks (see “The Price of Sin”).

Let’s face it.  Tobacco is not a growth industry, not even in most emerging markets.  While smoking remains popular in many, market penetration hit the high-water mark a long time ago.  And as health awareness rises with incomes, the best the industry can hope for is gentle decline.

Knowing this, long-term investors tend to by tobacco stocks for one and only reason—the high dividends they offer.

Yet consider how Philip Morris International’s dividend stacks up with other consumer-oriented companies with large footprints in emerging markets.

Company

Ticker

Dividend Yield

Forward P/E

Johnson & Johnson

JNJ

3.7%

12.1

Philip Morris International

PM

3.6%

14.8

Procter & Gamble

PG

3.8%

15.1

Unilever

UL

3.9%

13.7

 At current prices, investors can get a higher dividend yield in Johnson & Johnson (NYSE:$JNJ), Procter & Gamble (NYSE:$PG) and Unilever (NYSE:$UL), and Philip Morris International trades at a higher P/E ratio than all but Procter & Gamble.  And while each of these three examples has had its share of problems in recent years, the longer-term prospects for all are vastly superior to those for Philip Morris International.

Let me put it to you like this: 50 years from now, I suspect that Philip Morris International will still be selling plenty of cigarettes.  But I’m betting that Johnson & Johnson, Procter & Gamble, and Unilever are selling a lot more Band-Aids, razor blades, and shower gel, respectively.  I’m grossly oversimplifying the businesses of all three of these companies, but my point stands: Philip Morris International is only attractive if it is priced at a significant discount to mainstream consumer products companies like the ones mentioned in this article.

This condition does not hold today, which is why I must regrettably make Philip Morris International a “sell.” 

Investors looking for income these days still have plenty of decent options, even if reliable choices from years past are no longer as attractive as they might been.  Many oil and gas master limited partnerships offer attractive yields, as do select specialty REITs.  Telecom and utilities stocks are also attractive.  But at current prices, investors might find Philip Morris International’s stock as dangerous as its products.

Disclosures: Sizemore Capital is long MO, PG, JNJ and UL

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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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Diageo: The Ultimate 12- to 18-Year Play

Have you ever noticed that new “premium” vodka brands seem to pop up every other year, yet the quality scotch brands you see on shelves today are the same ones you might have seen in your grandfather’s liquor cabinet?

There is a reason for that. Vodka is colorless, flavorless and can be mass produced from scratch in a matter of days. For that matter, you can make it in your bathtub over a long weekend with basic ingredients from your kitchen.

Making an enjoyable scotch, on the other hand, takes years. In fact, whisky cannot technically be called “scotch” at all unless it has been aged in an oak cask for a minimum of three years.

Of course, if you offer a gentleman a scotch that has only been aged three years, he might take it as an insult. A decent scotch—be it blended or single malt—will generally be aged anywhere from 12 to 25 years or more.

Anyone can start an exclusive new vodka brand given a sufficient pool of capital. Consider the example of Grey Goose. The American billionaire Sidney Frank created the brand in 1997 and sold it to Bacardi just seven years later for a quick $2 billion. Had he opted instead to create a new scotch brand, he would not have lived long enough to enjoy its success. When the late Mr. Frank passed away in 2006, his first batch of scotch would have still needed another 5 years or more of aging to be taken seriously.

This is a significant barrier to entry for would-be newcomers. Imagine an enterprising scotch enthusiast attempting to start his own distillery today. What bank or venture capital firm would put up the money to get a distillery of any size in production given that the company wouldn’t have a sellable product for at least a decade?

Perhaps you could get the enterprise off the ground faster by buying existing aged inventory from a small independent distillery, but this is not something that would be feasible on an industrial scale. At best you would have a small craft business.

This brings me to a recent headline on Diageo (NYSE:$DEO) the British-based international spirits conglomerate and owner of the ubiquitous Jonnie Walker brand. In addition to Johnnie Walker, Diageo owns the J&B scotch, Crown Royale Canadian whiskey, Ketel One and Smirnoff vodka, Jose Cuervo tequila, and Bailey’s Irish Cream brands (among many others) and acts as distributor for the assorted cognacs of Moet Hennessy.

Diageo is investing $1.5 billion to expand its scotch production over the next five years. The news sent shares of Diageo’s stock price higher as investors interpreted the announcement as a bullish call on the company’s future.

Think about it. Diageo’s management must feel pretty confident about the future to expand its scotch operations on a grand scale. While some of the production used for the lower end Red Label line might be available in as little as 3-5 years, it will be at least 12 years before any whisky made in the new distilleries will be eligible to be used in a bottle of Black Label—and nearly three decades before it could be used in a bottle of the ultra-high-end Blue Label.

I have every reason to believe that this optimism is warranted. Over the past 5 years, the company has grown its top-line sales by over 50 percent—and the past five years have been rather challenging for most consumer-related businesses.

Much of this growth has been due to high demand from emerging markets—which already constitute 40 percent of Diageo’s sales and continue to take a bigger slice every year.

Call it the legacy of the British Empire. The United Kingdom controlled 25 percent of the world’s land mass at its apogee, and its influence spread far wider. And everywhere those ambitious British colonials went, they brought with them a thirst for scotch whisky. Outside of the United States—where Kentucky bourbon whiskey and Tennessee whiskey are popular—scotch is generally the only game in town.

As incomes continue to rise in China, India, Latin America and other brand-conscious emerging markets, so do standards of taste. Ordering a premium spirit or offering a bottle as a gift is a sign that you have “made it” in life. This is a long-term macro theme with decades left to run—which is perfect for Diageo’s premium scotch production timeline.

I should also add that Diageo is an International Dividend Achiever, meaning that the company has raised its dividend for a minimum of five consecutive years. I expect Diageo to continue raising its dividend at a nice clip in the years ahead. The stock currently yields 3.0 percent.

I won’t say this about too many companies, but Diageo is a stock that you can buy and forget. I recommend the stock for your core, long-term portfolio—and I also recommend you take the time to enjoy a bottle of Black Label, preferable with full-bodied cigar. And if Diageo performs as I expect, use your dividend proceeds to upgrade to a bottle of Blue Label.

Disclosures: Sizemore Capital is currently long DEO. This article first appeared on InvestorPlace.

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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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Harley-Davidson Sputters and German Beer Goes Flat

The news just doesn’t get better for Harley-Davidson (NYSE: HOG) and its peers in the “big bike” business. US motorcycle sales shrank by 14.1% in the third quarter from the year before, extending the grueling decline to 15 consecutive quarters. Remember, that is a 14.1% decline from the already deeply depressed sales figures of 2009.

According to the Financial Times, “Sales are now less than half the level at the peak of the market in 2006… Highway bike sales totalled 383,000 last year, down from 660,000 in 2008 and 724,000 in 2007.” (see US motorcycle sector extends decline)

How bad is it? Some of Harley’s Japanese competitors did not produce 2010 models.

I’ve written quite a bit about Harley-Davidson over the years (see prior posts). I can’t help but almost feel sorry for the company. You cannot say that Harley’s woes are due to bad management. Harley’s management team generally gets high marks. No, Harley-Davidson’s problem is bad demographics.
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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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