Tobacco stocks have found themselves shunned in recent years amid health concerns and a greater focus on ESG (environment, social and governance) investing.
Known as a consumer staple, tobacco stocks have long been considered as defensive investments. This is because in all market conditions, people need to go to the shops and buy staples such as foods, drinks and, in the past, tobacco.
However as smoking rates have steadily declined around the world and regulation has increased, tobacco companies have found themselves firmly in the spotlight. So is there still a place for these stocks, which were once considered recession proof?
The UK is home to two of the world’s largest tobacco stocks; Imperial Brands and British American Tobacco (BAT). Both are listed on the London Stock Exchange (LSE).
BAT has long been a popular UK defensive stock and it has been one of the highest yielding stocks on the FTSE 100 for years, as the addictive nature of nicotine means demand for its products stays stable regardless of the economic situation. Currently yielding 6.9%, its high operating profit margin, which topped 30% in 2019, helps to ensure the dependability of the corporate payout. BAT sits in the FTSE 100 and its primary listing is on the LSE. It has secondary listings on the New York Stock Exchange and the Johannesburg Stock Exchange.
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Formerly called the Imperial Tobacco Group, Imperial Brands is the world’s fourth-largest international cigarette company measured by market share. Listed on the LSE and a constituent of the FTSE 100, its brands include Davidoff, West, Gauloises Blondes, Montecristo, Golden Virginia (the world’s best-selling hand rolling tobacco), Drum (the world’s second-largest-selling fine-cut tobacco), and Rizla (the world’s best-selling rolling paper). Despite dividend growth of just 1% last year, and having to cut its dividend a couple of years ago, the company is currently yielding 8.1% which will be attractive to income investors.
A wave of consolidation in the industry has left just three major players in tobacco, outside of BAT in the UK the two major players globally are Altria and Philip Morris International. Investing in some global stocks means that you can diversify your portfolio, but you can also encounter foreign exchange fees and fluctuations.
According to Wharton Professor Jeremy Siegel, Altria Group – which is the domestic maker of the Marlboro brand – was the best performing stock on the US market from 1968 to 2017 when including reinvested dividends. During that time the cigarette makers’ annualised average return was 20%. Indeed in the last 50 years, it has raised its dividend 54 times. Given the long-term decline in tobacco smoking, the company has taken steps to diversify away from traditional cigarettes, taking a 35% stake in e-cigarette manufacturer Juul Labs and a 45% holding in the Canadian cannabis grower Cronos Group. Traded on the NYSE, Altria is a constituent of the S&P 100 and S&P 500 indices.
Philip Morris International (PMI) was an operating company of Altria until 2008, when it was spun-off. The Swiss-US company sells many of the same brand as Altria, such as Marlboro, but does so outside of America. Whereas Altria has looked outside of the company to diversify and cushion itself from the decline in cigarettes, PMI is focusing on heat-not-burn (HNB) products. Its primary offerings in this category are the devices and cartridges sold under its IQOS brand. Like Altria, PMI is dividend payer, raising its dividend every year since its split in 2008 and currently offering a yield of 5.7%. The stock is listed on both the NYSE and the SIX Swiss Exchange and is a constituent of the S&P 100 and S&P 500 indices.
A true consumer staple and one with a reputation of paying strong dividends to investors, for much of the last century tobacco stocks were very popular with investors. This is because they benefited from an additive, highly-profitable, recession-proof product.
However, a greater focus on the ethical side of investing has led to huge swaths of divestments from tobacco stocks. At the same time, amid health concerns and increasing regulations, smoking rates have declined globally. Not only has this led to consolidation within the industry, but it has also created a rethink by the major players.
As a result the industry has looked to evolve and focus on so-called next generation products like e-cigarettes and vaporisers. Not only do these create less odour, they are also perceived as being better for your health. At the same time, alongside cigarettes, tobacco companies continue to sell other chewing tobacco, cigars and accessories such as rolling papers.
“Tobacco stocks have been shunned for a number of years for ESG and health reasons, but should that stop investors?” asks Ben Yearsley, founder and director at Fairview Investing. “These stocks are on very cheap valuations, create lots of cash and will all be buying their shares back over the next few years as debt levels fall.”
He adds: “A shrinking equity base is good for shareholders who want to stay on board because it boosts their earnings per share (EPS). So with tobacco stocks you are getting high yield, good cash conversion and low price/earnings. The one downside is the health aspect.”
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Read the full methodologyIncreased regulation, falling smoking rates and more ethically-conscious investing are three huge headwinds facing the tobacco industry.
As a result revenue and profit growth have been slow across the entire industry, which has led to a wave of consolidation and, as a result, less stocks to invest in.
Alongside alcohol and gambling, tobacco companies sit in the category known as “sin stocks” given the adverse effect they have on the health of its users. This leads to a moral dilemma of benefiting from their success.
Indeed, according to the Wall Street Journal, PMI and Altria are the second- and third-most underweighted stocks in ESG portfolios relative to their weighting in the S&P 500 index.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
Investing in tobacco stocks all comes down to what is important to you as an investor. While known for being dividend aristocrats of the equity world, the old business model of selling products which can cause early deaths has increasingly not sat well with the investment community.
However what can’t be argued is that for those wanting income-producing stocks in their portfolios, tobacco stocks can still serve a purpose.
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