The centers for disease control just released a study that found fewer Americans than ever before are smoking cigarettes. The findings should be unsurprising to big tobacco companies which have been dealing with falling demand for their key product for years already. Industry analysts say U.S. cigarette sales are off around four percent this year.
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So, it’s quite impressive that big tobacco stocks are up 25% or more year to date and largely outperforming the broader market. Tobacco stocks also pay a handsome dividend.
Altria group (MO) pays out 4%!
How are they doing it? And can the run continue?
First, the bullish case. Asian sales are on fire. The World Health Organization reports that of China’s 1.3 billion population, more than 300 million already smoke.
What’s more, the industry is consolidating. Lorillard (LO), maker of Newport Menthols, and Reynolds American (RAI), maker of Camel, Pall Mall, and Natural American Spirit, announced in July a $27 billion plan to combine. The deal will allow them to streamline costs, shed assets, and ultimately boost the bottom line.
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Another bright spot for big tobacco are e-cigarettes which are catching on and turning out to be a good source of revenue. Sales of e-cigs surpassed $1 billion last year and are expected to at least double this year. As part of the Lorillard/Reynolds American deal, Lorillard will divest its Blu e-cigarettes brand so that the new company can focus on Reynolds’ brand called Vuse. The jury still out, however, whether ‘vaping,’ or sucking on a plastic device that heats nicotine is significantly more healthy than inhaling carcinogen-filled smoke. And as of right now, e-cigarette sales are still only a fraction of the $80 billion in annual U.S. tobacco sales.
The big picture here is that more people are quitting tobacco or refusing to ever start. Governments, including Chinese lawmakers, are cracking down on smokers, charging high taxes and limiting public smoking areas. Even retailers are pulling tobacco products off of store shelves. The CVS (CVS) drugstore chain was the first to do this in the U.S. and even though reported a decline in so-called ‘front of store sales,’ still reported better than expected revenue the first quarter since introducing the policy. Will others retails follow CVS?
There are also concerns that big tobacco stocks are expensive relative to the broader market. The price to earnings ratio – a measure of stock valuation – for both Reynolds American and Altria group are a couple of points above the S&P 500.
So, keep an eye on big tobacco. These are transitional times. It’ll be fascinating to see if and how these classic sin stocks can filter in a new spark of business.