Tag Archives | vice investing. Big Tobacco

Plain Packaging: An Assault on Big Tobacco Branding

Last month, I wrote that Australia’s plain-packaging law was one of the worst setbacks for Big Tobacco in decades because it attacked the companies’ single most valuable asset: their brands.

Big Tobacco has strong enough moats to survive high taxes, punishing lawsuits, and an aging and declining customer base intact.  But plain packaging threatens the industry at its very core, and this is something underappreciated by investors in the sector.

James Dean

Cigarette Marketing 101

Long-time chain smokers light up for one very obvious reason—they are addicted to the nicotine.  But for casual smokers—those who may light up while drinking, for example—the experience matter 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 flipside.

If you think I’m making this up, consider the recent grumbles coming out of Australia.  Following the implementation of the plain packaging law at the beginning of this year, Aussie smokers  have complained that their cigarettes taste different.

The Australian health minister, quoted by the New York Times, insisted that there had been no change to the cigarettes themselves but that “people being confronted with the ugly packaging made the psychological leap to disgusting taste.”

I’m not a cigarette smoker, though I do enjoy the occasional cigar.  And I would insist that a cigar does indeed taste better when the smoker is wearing a suit and sitting in a comfortable leather chair surrounded by wall-to-wall shelves of old books.  The very same cigar smoked in a plastic lawn chair while wearing Crocs just isn’t the same (and shame on any grown man for wearing Crocs outside of the pool, but I digress).

Rational?  No.  But nonetheless true.

It remains to be seen whether plain packaging laws spread outside of Australia; they are being considered in Canada, India, the UK and in the European Union as a whole.  Big Tobacco wll argue that the ban violates their trademarks and seizes their intellectual property, and they may find a few sympathetic judges.  But given the history of the anti-tobacco movement, it’s a lot more likely that Big Tobacco will fight a rearguard action for years before ultimately losing.

So, if the future is bleak, does this mean that you should avoid tobacco stocks like Altria, Reynolds American ($RAI) or Lorillard ($LO)?

Not necessarily.  As I’ve written before, industries in decline can be fantastically profitable investments under the right set of conditions.  But the most important condition is price, and on this count Big Tobacco looks far from attractive.  Altria, Reynolds American and Lorillard trade for 17, 19, and 15 times earnings, respectively.  Their dividends, while high by broad market standards, are all lower than 5%, and all are trading near their 52-week highs.

Dividend income is a major consideration in my investment process, but I am avoiding Big Tobacco at this time.  I can get higher yields with comparable dividend growth rates in select REITs and MLPs, and I can get a much higher dividend growth rate in Big Tech names like Microsoft ($MSFT), Intel ($INTC) and Cisco Systems ($CSCO).

Do I expect Big Tobacco stocks to take a nosedive in the immediate future?

No, I don’t.  I expect the sector to more or less track the market in the short term.  But Big Tobacco investors should be aware that the single biggest factor in the sector’s outperformance of recent years—price—is no longer in their favor.

Sizemore Capital is long MSFT, INTC, and CSCO.

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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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Big Tobacco Botches the E-Cig Name Game

Back in April, I asked if E-Cigarettes would relight Big Tobacco’s prospects.   I had my doubts.

bogart_casablancaE-cigs seemed to be a more pleasurable version of a nicotine patch: something that an existing smoker might switch to for health reasons but not exactly an attractive or glamorous product for someone who doesn’t already smoke.  (Humphrey Bogart would not have been as cool in Casablanca with an e-cig dangling between his lips.  This is an indisputable fact, not an opinion.)

It certainly made sense for Altria ($MO), Reynolds American ($RAI) and the rest of Big Tobacco to get in on the action; it’s better to extract a little more revenue from defecting cigarette smokers than to lose them altogether.

But investors should be realistic about the potential for e-cigs to make Big Tobacco a growth industry again.  It’s not going to happen.  Though there are hundreds of millions of tobacco users worldwide (the World Health Organization puts the number of tobacco users at over 1 billion), public health campaigns, legal restrictions, and changing consumer tastes have put cigarette smoking in terminal decline in the developed world.  As a sobering (no pun intended) case in point, American teenagers are more likely to use illegal drugs than to light up a cigarette.

Perhaps most damaging, new “plain packaging” rules are directly assaulting the single most valuable assets of Big Tobacco companies: their brands.

In Australia, all cigarette boxes look identical, regardless of brand: plain white boxes with the brand name written in a uniform font, size, and placement.  Oh, and the same graphic photos of people dying of lung cancer on the back.

Similar rules are being considered in Canada, India, the UK and the European Union.  Big Tobacco is fighting it tooth and nail on trademark and intellectual property grounds, and I consider their objections valid.  But the assault on branding seems to be the next front in the ongoing war of attrition between public health advocates and Big Tobacco, and if history is any guide, the public health advocates will win.

This brings me back to e-cigarettes.  Altria is jumping into the e-cig market with a new product under the brand name Mark Ten.  Nowhere on the packaging will there be any prominent mention of Altria or its best-known brand, Marlboro.

I’m left scratching my head here.  There are over 250 e-cigarette brands currently on the market.  While I don’t see a smoker paying a large premium for a Marlboro-branded e-cig, I would certainly expect them to gravitate to a brand they already know.  In failing to use the Marlboro name, Altria seems to be neutralizing its single biggest strength: a consumer brand that is behind only Coca-Cola ($KO) and Anheuser-Busch InBev’s ($BUD) Budweiser in name recognition.

This would be tantamount to calling Diet Coke “Healthy Pop” and leaving all mention of the Coke brand off the can.  It’s madness.

If Big Tobacco is wanting to start fresh with new branding because of the toxic association between the existing brands and those filthy, old traditional cigarettes, they are wide off the mark.  Their market is existing smokers, not nonsmokers.  Unless they brand e-cigs as “portable flavored hookahs” or something with novelty appeal, it’s hard to imagine this product appealing to a young, unbiased consumer.

And this actually brings me to a related topic.  I noted last month that marijuana stocks were a terrible investment.  The companies engaged in legal production and marketing are small, poorly capitalized, and not likely to still be in business five years from now.

But as the legal regime surrounding their product continues to be relaxed, there may be room for a large, well-capitalized company to sweep in and take over the market.  Big Tobacco’s massive production and distribution machine could be easily tweaked to sell packaged marijuana cigarettes—which could be branded under familiar brand names such as Marlboro or Camel.

A lot of Americans would be put off by this, of course.  Fully 49% of Americans are against marijuana legalization for very valid reasons.  But the question Big Tobacco needs to ask is this: can their reputation get any worse than it already is?

Big Tobacco is already a pariah industry under constant attack.  What would they have to lose by marketing marijuana cigarettes in Colorado and Washington?  It’s hard to see a loyal cigarette smoker kicking the habit because “their” brand has now been tarnished by tie-dye wearing hippies.

At any rate, if Big Tobacco is going to continue to be a good investment for its shareholders, management needs to focus on leveraging their core brands.  The alternative is to slowly fade away.

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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The Russian Smoking Ban: Will It Snuff Out Big Tobacco Profits?

Life hasn’t gotten any easier for Big Tobacco.  Last week, Russia became the latest country to impose major new restrictions on smoking in public places.  Starting in June, Russians will no longer be able to smoke in restaurants, and cigarette advertising will be banned.

I have my doubts as to how strictly the ban will be enforced, but the fact remains that one of the friendliest countries towards public smoking just got a lot chillier.  According to the Wall Street Journal, 44 million Russians smoke, and they collectively account for 9% of Philip Morris International’s (NYSE:$PM) profits.  Japan Tobacco and British American Tobacco (NYSE:$BTI) get 11% and 8% of their profits from Russia, respectively.

Russians will not quit smoking overnight in response to the ban. That didn’t happen in the United States, and it won’t happen in Russia.  It may be years before it makes a serious dent in consumption.  But it does blow a major hole in one of the bullish arguments supporting Philip Morris International: emerging markets will not be growth markets for tobacco forever.  As countries reach higher levels of development, the costs to the health system prompts a crackdown.

We saw the same in China.  In 2011, China banned smoking in restaurants, bars, and in several other enclosed public spaces, though it is still legal to smoke in offices. But there are now plans to ban smoking in virtually all public place, New York City style, by 2015.

Again, we’ll see how strictly it is enforced.  Though China has no qualms with crushing freedoms of expression or religion, the right to light up a cigarette is one they seem to let slip.

Latin America?  Same.  Brazil, Argentina, Chile, and Peru all have bans in most indoor areas, and enforcement is starting to be taken seriously.

India?  You guessed it.  As of 2008, smoking was banned in most public places, though enforcement has been a little touch and go.

By now, you should be getting the picture.  Though enforcement varies from country to country, there is really no such thing as a “tobacco friendly” country anymore.  Everywhere you look, the noose is getting tighter.

Sizemore Insights readers know that I have been a Big Tobacco fan for a long time.  They tend to be dividend-paying powerhouses with consistent returns.  And like other “vice investments,” they tend to be priced as perpetual value stocks, which has made them an outstanding performer in recent decades.

But I don’t advocate buying tobacco stocks at any price.  Tobacco stocks have been a great investment precisely because they were cheap and no one wanted them.  But you can’t make that argument today.  In fact, if anything they have become trendy.

Last month, I wrote that At Current Prices Tobacco is a No-Go, and I want to repeat that sentiment today.  Domestic Big Tobacco stocks such as Altria (NYSE:$MO) and Lorillard (NYSE:$LO) trade at a slight premium to the S&P 500 earnings multiple.  That simply should not be.  These are companies in terminal, albeit gentle, decline.

And Philip Morris International, the “growth stock” of the bunch, trades at a significant premium.  Philip Morris trades for 18 times trailing earnings and yields 3.7%.  That is simply not a high enough dividend yield to make this stock worthwhile given the better alternatives out there.  “Boring” tech stocks like Intel (Nasdaq:$INTC) and Microsoft (Nasdaq:$MSFT) both offer higher dividend yields, as do most midstream master limited partnerships.

If Big Tobacco has a substantial price correction, then I might be interested again.  But for now, I consider these stocks as toxic as the cigarettes they sell.

Disclosures: Sizemore Capital is long MSFT and INTC.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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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Tobacco Stocks: Watch Your Ash!

Victory for Big Tobacco investors

I like the occasional cigar after a hard week at the office, though I can hardly call myself a connoisseur.  And I’ve always been impressed by experienced smokers who can smoke their cigars down to a perfect ash without it crumbling off and landing in their laps.  I’ve seen ash still perfectly intact at 2-3 inches.

That’s impressive.  Though you’d never think for a moment that it was sustainable.  Eventually, the ash will break and fall to the floor.

This is how I feel when I look at tobacco stocks today.  And I say this as a long-time bull in sin stocks in general and tobacco stocks in particular.  Some of the best investments I have ever made have been in tobacco stocks.  But at current prices, I prefer to sit in the no-smoking section.

Over the past month, dividend-focused sectors such as utilities, MLPs and REITs have all trended down as investors worry about higher dividend taxes coming in 2013.  Yet Big Tobacco continues to drift higher like a smoke ring (another party trick I was never able to do).

Company

Ticker

1-Month Performance

Philip Morris International

$PM

3.0%

Lorillard

$LO

4.7%

Altria

$MO

6.0%

Reynolds American

$RAI

7.2%

 

Something is amiss here.  Tobacco is a zero-growth business.  Your only realistic source of return is from the dividend.  I would go so far as to say that tobacco stocks are the most-dividend-focused stocks of any sector or subsector.

I understand the appeal of tobacco stocks.  They are a defensive consumer staple and they represent stability in a volatile market.  And in a world where bonds yield less than 2% and savings accounts yield nothing, a 3-5% dividend can seem pretty attractive.

Yet the same arguments can be (and are) made of REITs and MLPs, and these also have far better potential for capital gains.  If investors are concerned about the fiscal cliff and dividend taxes, then they should be selling tobacco stocks along with their utilities and other income-oriented stocks.

Tobacco stocks are also shockingly expensive. Altria (NYSE:$MO), the maker of Marlboro among other brands, currently trades at 17 times earnings—significantly higher than the broader S&P 500.  Philip Morris International (NYSE:$PM) has a significantly lower dividend yield than chip juggernaut Intel (Nasdaq: $INTC).

Remember, we’re talking about tobacco here.  The substance that requires warning labels and gruesome graphics on the side of package…and a substance that fewer people use every passing year.  Tobacco stocks should trade at a discount to the broader market, and they generally do.  In fact, this chronic underpricing has been a major driver of returns over the past several decades.  But without the underpricing, I cannot consider tobacco stocks worthy of purchase.

Investors hunting for yield would be better off buying a basket of quality MLPs and REITs or even a dividend-focused ETF like the Vanguard Dividend Appreciation ETF (NYSE: $VIG).

Are tobacco stocks about to go up in smoke?

Maybe, maybe not.  As long as yields stay low, tobacco stock prices could stay high.  Still, the divergence from other dividend-focused sectors is a major red flag for me.

My recommendation: If you do not already own tobacco stocks, stay away.  If you do own highly-appreciated tobacco stocks, consider selling.  Or at least tighten your stop losses.  Sizemore Capital has sold most of its tobacco positions, but we have two long-term positions in Altria and Philip Morris International that we have held for multiple years.  But even on these positions, we are tightening our stop losses and preparing to sell at the first sign of weakness.

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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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