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.
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 (NYSE: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 (NYSE:RAI) or Lorillard (NYSE: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 (NASDAQ:MSFT), Intel (NASDAQ:INTC) and Cisco Systems (NASDAQ: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.
About the author:
Mr. Sizemore has been a repeat guest on Fox Business News, has been quoted in Barron’s Magazine and the Wall Street Journal, and has been published in many respected financial websites, including MarketWatch, TheStreet.com, InvestorPlace, MSN Money, Seeking Alpha, Stocks, Futures, and Options Magazine and The Daily Reckoning.