Tag Archives | vice investing

Marijuana Stocks: You Would Have to be High to Buy Them at Current Prices

I’ve been a big believer in vice investing—and particularly tobacco stock investing—for a long time.  I turned bearish on tobacco stocks late last year, but this was based purely on price.  In my view, tobacco stocks had simply gotten too expensive relative to other dividend-paying options—and I would reiterate that view today.

But if ol’ tobacky stocks are unattractive at current prices, what about wacky tobacky stocks?

With marijuana slowly becoming legalized in the United States (at least on a state-by-state basis), manufacturers and vendors of cannabis are evolving from enterprises of dubious legality into mainstream and regulated purveyors of vice.

So, if Big Tobacco has been a profitable investment despite its social stigma, might Big Weed get a haircut and get to work for investors?

Maybe, but I wouldn’t count on it.

To start with, there is no “Big Weed.”  All of the players are small companies with names that few investors have ever heard of.  Tobacco and marijuana are also vastly different industries with vastly different competitive dynamics.  Yes, both could be lumped into the category of “sin stocks,” but not all sin stocks are created equal.  This requires a little explaining.

I recently wrote that Coca-Cola and Pepsi were the “New Big Tobacco.” By this I meant that sugary drinks were evolving into a stigmatized industry that is regulated in the interests of public health in the same way that cigarettes are.  But I also noted that the stocks of companies operating under that kind of scrutiny can still be wildly profitable to own under the right set of conditions:

  1. There should be substantial barriers to entry for new competitors (what Warren Buffett likes to call “moats.”)
  2. The company should be financially healthy (strong balance sheet, manageable debt, etc.)
  3. Management should be committed to rewarding shareholders with rising cash dividends and, to a lesser extent, share repurchases.
  4. The stock must be cheap.

Big Tobacco names like Altria (NYSE:MO), Philip Morris International (NYSE:PM), and Reynolds American (NYSE:RAI) easily pass the first three criteria. They just happen to bomb the fourth.

So, how do marijuana stocks look in comparison?

The first point is in a state of limbo.  There were arguably barriers to entry under the old medical marijuana regime due to the legal hoops that growers and vendors had to jump through.  But none of the existing players were big enough to crush new competition, and none had any real name recognition.

Virtually every human being alive today is familiar with Altria’s Marlboro brand or Anheuser-Busch InBev’s  (NYSE:BUD) Bud Light, regardless of whether they smoke tobacco or drink alcohol.  But how many have heard of Medical Marijuana Inc (Pink sheets: MJNA), one of the largest suppliers of medical marijuana? Or Cannabis Science (Pink sheets: CBIS), one of its biggest competitors? Or for that matter, how many have heard of Growlife (Pink sheets: PHOT), a leading seller of hydroponic equipment?

I’m betting the answer is not too many.  At this stage in the game, there is no real brand recognition to speak of.

What about the other criteria?  Are these companies at least financially sound, and do they reward shareholders via dividends and share buybacks?

Not exactly.  All three companies are high-risk penny stocks, and none pay a dividend.  Of the three, Medical Marijuana, Inc., the “blue chip” of the group, has the healthiest balance sheet, but you’re talking about a company that generated only $5 million in revenue last quarter.

And price?  Medical Marijuana, Inc. trades for 14 times book value and 24 times sales.  To pay those prices for any stock…well, let’s just say you’d have to be heavily under the influence of the company’s products.

At time of writing, Medical Marijuana, Inc., Cannabis Science, and Growlife trade for $0.17, $0.05 and $0.04 per share, respectively.  But a young analyst I interviewed on the matter told me he had a price target of $4.20 on all three.

I think there was a joke in there somewhere at my expense.

Bottom line: while marijuana stocks may indeed be vice investments, they have none of the qualities that have helped tobacco generate such fantastic returns over the past 50 years.  Treat them as a risky speculation and nothing more.

Sizemore Capital has no positions in any stock mentioned. This article first appeared on InvestorPlace

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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Can E-Cigarettes Relight Big Tobacco?

Has Big Tobacco stumbled into a new growth market in electronic cigarettes?

Well, sort of.  Use of e-cigarettes—which produced a smokeless water vapor infused with nicotine—is expected to more than double in 2013, which might ordinarily be good news for the major tobacco giants. Altria (NYSE:$MO), Reynolds American (NYSE:$RAI) and Lorillard (NYSE:$LO) are all active in the market or have concrete plans to be active. 

But the increasing popularity of e-cigs has come at the expense of the smoky originals.  By Morgan Stanley estimates, e-cigarettes replaced 600 million “stick equivalents” last year and will replace 1.5 billion in 2013.  Varying estimates have e-cigarettes accounting for 0.5% to 1.5% of all cigarette sales.

Growth is not something we’ve come to expect from the tobacco industry.  Yes, cigarette stocks have produced fantastic returns for investors in recent years, but these stock market returns have come even while unit cigarette sales have continued their drift lower.  American cigarette sales fell by 6.2% last year to 289 billion sticks; as recently as 2001, the number was well over 400 billion.

What does this mean for Big Tobacco and its investors?

The tobacco industry has been very effective at managing the economics of decline, much to the benefit of shareholders.  Altria and Philip Morris International (NYSE:$PM) were core holding of the Sizemore Investment Letter for most of 2010 and 2011, and our readers enjoyed fantastic returns driven by the relentless search for yield by investors in the low-rate world of quantitative easing.

There is absolutely nothing wrong with investing in an industry in decline, so long as the right conditions are in place.  As I wrote last week (see Are Coke and Pepsi the New Big Tobacco?), those conditions are:

  1. There should be substantial barriers to entry for new competitors.
  2. The company should be financially healthy (i.e. strong balance sheet, low debt).
  3. Management should be committed to rewarding shareholders via dividend hikes and/or share repurchases.
  4. The stock price should be cheap relative to the broader market.

How do e-cigs affect these criteria?  To start, they erode those all-important barriers to entry.

Outside of military armaments, Big Tobacco might be the most highly-regulated industry on the planet.  Though it sounds onerous, it’s actually quite good for the large existing players because it makes it virtually impossible for new upstarts to come in and undercut the established brands on price.

There is one big problem here.  The legal regime is still being formed for e-cigarettes, and right now it is something of a free-for-all that doesn’t necessarily favor existing Big Tobacco.  It varies from city to city or bar to bar, but e-cigs are also generally free of the indoor smoking restrictions that have helped to curtail tobacco use.

Would smokers be likely to pay a premium for an e-cigarette branded with the Marlboro label?  Maybe.  Maybe not.  But I’m betting the answer is no.

Rather than being a durable growth business for Big Tobacco, 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.

Patches and gum did not destroy the tobacco industry, and neither will e-cigarettes.  But they may speed up its long-term decline.  According to the Wall Street Journal, e-cigarettes might have been a major reason that cigarette sales declined by over 6% last year rather than the usual 3-4%.

But in the end, the only aspect that matters to tobacco investors is how much of this is factored into current prices.  Remember, item #4 above—for an investment in an industry in decline to make sense, it has to be priced accordingly.  And right now, Big Tobacco stocks actually trade at a slight premium to the broader S&P 500.

I could be wrong, of course.  Rather than hasten the decline of traditional cigarettes, the e- variety may offer a real avenue for growth.  But given how quickly the industry is shrinking, it is hard to see any growth of this front offsetting the declines in unit sales.   And none of the above justifies a premium multiple.

If you’re looking for sustainable dividend growth at a reasonable price, Big Tobacco is not your best option at the moment.  As I wrote earlier this year when I called semiconductor maker Intel (Nasdaq:$INTC) my favorite “tobacco stock,” you’re a lot more likely to find value in Big Tech.

Sizemore Capital is long 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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Are Coke and Pepsi the New Big Tobacco?

Earlier this year, I commented that semiconductor titan Intel (Nasdaq:$INTC) was my favorite tobacco stock.

I said this tongue-in-cheek, of course.  I am aware that Intel designs and manufactures microprocessors, not cigarettes.  But my point was simply that slow-growth (or even no-growth) investments, such as tobacco stocks, can be wildly profitable under the right conditions:

  1. There should be substantial barriers to entry for new competitors (what Warren Buffett likes to call “moats.”)
  2. The company should be financially healthy (strong balance sheet, manageable debt, etc.)
  3. Management should be committed to rewarding shareholders with rising cash dividends and, to a lesser extent, share repurchases.

But most importantly, even if all of these other conditions are met, the stock must be cheap.  Remember, if this is an industry in decline, you cannot pay top dollar for the stock and expect to have decent returns going forward.

Big Tobacco giants such as Altria (NYSE:$MO), Reynolds American (NYSE:$RAI) and Philip Morris International (NYSE:$PM) easily pass the first three conditions.  All benefit from the moats encircling the tobacco business (it would be all but impossible to start a new cigarette company today), all are financially healthy, and all solid dividend payers and growers.

Yet none is particularly cheap at the moment; all trade at a premium to the S&P 500’s earnings multiple.

Big Tobacco’s rich valuations these days are particularly noteworthy because tobacco is not just any run-or-the-mill no-growth industry.  It’s also a vice industry and perhaps, outside of firearms, the biggest of all social pariahs.

In many American cities, cigarette smoking is for all intents and purposes illegal.  Smoking in indoor public spaces like bars and restaurants is not allowed, and in the most aggressive cases (such as New York City) even smoking in outdoor public parks is prohibited.  But even where smoking is less persecuted, it’s not exactly welcome.

And this brings me to the crux of this article.  Princeton professor Harrison Hong and University of British Colombia professor Marcin Kacperczyk published an insightful paper in 2005 titled “The Price of Sin.”

The professors showed that social stigmas against investing in vice industries such as tobacco and firearms cause the stocks of companies in these industries to be depressed due to lack of institutional ownership.  No college endowment fund, foundation, or pension plan wants to be labeled a “merchant of death.”  As a result, vice stocks tend to be priced as perpetual value stocks and thus deliver market-beating returns over time.

So…by this rationale, wouldn’t Coca-Cola (NYSE:$KO) and Pepsico (NYSE:$PEP) be vice investments too?

New York Mayor Michael Bloomberg certainly seems to think so.  About the only thing he has fought as hard as tobacco is super-sized sodas.  His controversial ban on all sugary sodas larger than 20 ounces in NYC was tossed out in court, but he’s not throwing in the towel just yet.  His war against Coke and Pepsi will be a war of attrition.

And Bloomberg is not alone.  First Lady Michelle Obama has actively campaigned against soda consumption as part of her anti-child-obesity efforts. Calorie counts started appearing in menus a few years ago, and calls for assorted “fat taxes” have sprung up across various parts of the United States and Europe.  Japan—not normally a country associated with an obese population—started measuring the waist lines of its citizens in 2008 and requires diet changes for anyone deemed too fat.

How fat is “too fat”?  Try a 33.5-inch waist line for men and 35.4 inches for women.  I’m willing to bet that most of my readers would fall outside these bounds given that they are well below the American average.

Anti-tobacco laws did not spring up overnight.  It was a gradual process taking place over decades.  Smoking rates declined over time, driven more by changing attitudes than changing laws.

Is something similar happening to soft drinks?  Indeed it would appear so.  U.S. soda consumption fell in 2012 for the eighth consecutive year.  Even more foreboding, consumption per person is at the lowest levels since 1987.

Sales are still strong in emerging markets…for now.  But rising emerging-market incomes will only provide a temporary boost, if tobacco is any indication.  As incomes rise, so does health awareness.

But does any of this actually matter to Coke and Pepsi shareholders?  I made a strong case for slow-growth companies, and both Coke and Pepsi meet my first three criteria.  Both have enormous moats due to their branding power and global distribution (If you’re the investor of a new soft drink, you shouldn’t waste your time; Coke and Pepsi will bury you.) Both companies are financially healthy, and both have long histories of strong dividend growth.  On the dividend front, both Coke and Pepsi are proud members of the Dividend Achievers Index and major holdings of my favorite ETF: the Vanguard Dividend Appreciation ETF (NYSE:$VIG).

 Coke Pepsi

But what about price?  Coke and Pepsi have both seen price/earnings multiple contraction since the go-go days of the 1990s; for that matter, so has the entire U.S. stock market.

Yet both sport current multiples well above the market average of 17, making them too expensive to be “tobacco stocks.”  (Of course, tobacco stocks are too expensive to be “tobacco stocks” too, so at least they have something in common.)

marlboro_manPricing here is complicated.  Coke has what is by most accounts the most valuable brand in the world, and Pepsi’s brands are also quite valuable.  It is the value of these brands that allows the stocks to trade at premiums to the market even while their core products are seeing weak demand.  But then, 20 years ago, I might have said the exact same thing about the branding power of the Marlboro Man.  Altria still has branding power relative to its Big Tobacco rivals, but this has to be viewed within the context of a shrinking industry.

In other words, I don’t expect Coke’s brand, as iconic as it is, to justify a premium valuation forever.

Bottom line: It would appear that Coke and Pepsi are slowly transitioning into vice stocks, though they are not quite there yet based on valuation.  Both stocks pay solid dividends and have a history of growing their dividends.  But at current prices, I wouldn’t expect either to outperform the market by a wide margin.

And on a final note, I’m going to be a proper Texan by enjoying a Dr. Pepper with my lunch.

Sizemore Capital is long VIG

 

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 Playboy Leveraged Buyout, Two Years Later

Almost exactly two years ago, I wrote a short piece on Hugh Hefner’s leveraged buyout of Playboy Enterprises and commented that the company was transitioning away from its adult media businesses and into licensing and brand management.  Essentially, founder Hugh Hefner wanted to turn his company into something like a Dolce and Gabbana, but with an edgier reputation.

It’s easy to understand Hefner’s motivation.  The internet had taken a wrecking ball to his business model.  Magazine and newspaper sales are in terminal decline. (Remember, men buy Playboy Magazine for the articles. Really.)   And it’s difficult to turn a profit in adult media given that you’re effectively competing with free.

hefPlayboy Enterprises definitely had the pieces in place.  The Playboy bunny is one of the most recognizable brand logos in the world, and the robe-wearing, pipe-smoking Hefner is a brand in of himself.  Long after the 86-year-old Hefner passes, his image will have marketability.  It’s crass, but it sells.

Incidentally, Hefner is grooming his 21-year-old son Cooper to wear the robe and carry the pipe after he is gone, becoming the public face of Playboy.  Given that the company already has professional management currently led by CEO Scott Flanders, it’s not entirely clear what the young Mr. Hefner’s role will be other than attending extravagant parties with beautiful young women on each arm.  I suppose it’s a hard job for a young, red-blooded American male, but someone has to do it.

All joking aside, the young Hefner’s role will be extraordinarily important if Playboy Enterprises is to have a future.  Because now more than ever, the company is selling a feeling rather than a product: the aspirational image of the modern bon vivant. Think about the “most interesting man in the world” commercials for Dos Equis beer.  This is the image they are going for.  If Cooper Hefner is to sell the lifestyle as effectively as his dad, he has a large robe to fill.

So, how is the company’s transformation going?

Actually, not that bad.  Since taking control of the company in 2009, Flanders has cut the payroll by 75% and sold off some its older media businesses.  Revenues are down from $240 million in 2009 to just $135 million in 2012.  But profits have nearly doubled, from $19.3 million to $38.9 million (measured as adjusted EBITDA).

Playboy is distancing itself from what most people would consider pornography, ditching its video business and offering media without nudity.  The Wall Street Journal calls it Less Smut, More Money. The company even has an iPhone app and a SiriusXM radio station.  And of course, there was the popular E! series The Girls Next Door.

The company is hoping to go public again in 2014, but it’s going to have a hard time getting there.  Licensing only accounted for $62 million of its $135 million in revenues last year, and the magazine continues to lose money.  The company is in violation of its loan covenants and may get downgraded by Standard & Poor’s.  And Playboy Enterprises’ ability to grow and go further mainstream will be limited by its toxic association with pornography and by the general cloud of sleaze surrounding its image.

And if the company does go public again, institutional investors will not exactly be lining up to buy shares.  If tobacco, alcohol and gaming stocks are difficult to own in the age of political correctness, then imagine having to justify a social pariah like Playboy to the trustees of a pension plan, foundation, or university endowment.

I wrote last year that Not All Sin Stocks are Created Equal, and Playboy Enterprises is a perfect case in point.  Its brands have value, but its core businesses have no moats.  If the company is successful in cleaning up its sleazy image and builds its licensing revenue streams high enough to compensate for a failing print media business, then the company might have a future.  Whether that future is enough to sustain the lifestyle created by Mr. Hefner is another story.

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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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Watering Down the Whiskey: Bullish or Bearish for Beam?

Southerners are a proud, prickly lot who, not that long ago, used to demand satisfaction for slights real or imagined with pistols at dawn.

An offended Bourbon drinker demanding satisfaction

An offended Bourbon drinker demanding satisfaction

The executives at Beam Inc, (NYSE:$BEAM) might want to watch out because their decision to water down their premium Maker’s Mark has offended the sensibilities of Bourbon lovers in the South and beyond.

And why would Beam do such a dreadful , dreadful thing?

They’re running out of quality aged Bourbon to sell.  High-end Bourbon has become so popular, Maker’s Mark lacks sufficient inventory to meet demand.

Bourbon is a fantastic business to be in.  I recently wrote about the massive competitive advantages that premier Scotch whisky brands have over their would-be competitors.    Unlike vodka, which can be produced from anything and has no aging requirements, Scotch has incredible barriers to entry.   A bottle of Scotch worth drinking is filled with whisky that has been aged for well over a decade.  Not too many start-up distilleries can afford to wait that long.

On a side note, once whiskies are bottled, the aging process stops.  Wine continues to age after it is bottled, but it is the only alcoholic beverage for which that is the case.  So if you have a good bottle of Scotch or Bourbon you’ve been itching to open, go for it.  It won’t have value five years from now as a collector’s item.

For American Bourbon, the rules are little looser.  Unlike Scotch, Bourbon has no required aging period.  But a bottle worth drinking has been “aged to taste.”  And in the case of Maker’s Mark, that aging period tends to be about five to six years.

If you’re the executives running Maker’s Mark, what do you do?  Shorten the aging period and risk lowering the quality of the finished product?  Accept shortages?  Raise prices and risk losing customers to other brands?

In the end, management decided that lowering the alcohol content by 3% was the least bad option and that its drinkers would not notice a difference in taste.  Other than risking an honor challenge from an offended white-glove-wearing Kentucky colonel, this would seem the least risky course of action.

Rival Brown-Forman (NYSE:$BF_B) lowered the alcohol content of its signature black label Jack Daniels from 86 proof to 80 proof in 2002.  It caused a little grumbling but it did no long-term damage to the brand.  In the case of Beam and Maker’s Mark, it should be safe to assume the same.  If spreading the whiskey a little thinner helps Beam to maintain its high sales growth a little longer, then this is a positive for Beam shareholders.  It also suggest that price hikes might be coming next, which suggest higher margins.

This boom in Bourbon demand is happening alongside a boom in Scotch demand.  As I wrote in my last article,  £2 billion in new distillery investment is underway in Scotland, much of it funded by the major brands like Diageo’s (NYSE:$DEO) Johnny Walker.

But while the economics of the whiskies businesses have never been better, I’d recommend steering clear of bourbon stocks.  Beam and Brown-Forman both trade for 25 times trailing earnings, which is a little too rich for my tastes.  I like spirits stocks, but not at any price.

Diageo is far from cheap at 18 times earnings, but I consider it the safest bet of the three.  I’ve owned shares for years, and I continue to reinvest my dividends.  But I’m not making any major new purchases at current prices.

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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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