Submitted by
Sizemore
Investment Letter
as part of our
contributors
program
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 (see
"Not 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:
- 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.
- 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.
The post It's Time to Stop Bogarting Cigarette Stocks appeared
first on Sizemore Insights.
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