Tobacco Company Yields are Smokin'

No, it’s not recession proof, but who wouldn’t have taken a 25% decline in their industry in a year when the market overall declined 40%? To top it all off: On an equal weighted basis, this industry index offers a 6% dividend yield. If you held the index at the beginning of the year, you’d have been paid 4.5% for patiently riding out the recession without the pain of a 40% decline.

So, what companies make up this index? Tobacco companies. Cigarettes, smokeless tobacco, and stogies. One of the worlds oldest and simplest businesses. Say what you will about tobacco being a vice, there are few more shareholder-friendly stocks than tobacco stocks. The AMEX Tobacco Index features includes 8 major tobacco companies. Only one does not pay a dividend. Of the dividend paying businesses, all feature significant payout ratios (>30%).

With increasing awareness about the health hazards related to smoking and smokeless tobacco, these businesses will not present you with the high growth prospects of some other stocks. That being said, this is an oligopolistic industry backed explicitly (or accidentally depending on who you talk to) by the government. Restrictions against marketing tobacco products severely handicap new brands, much less new market entrants. Heavy taxes make tobacco companies a golden goose to federal and state governments, so despite the hooting and hollering of attention grabbing politicians, it’s unlikely these businesses will be killed any time soon. Add in a captive (read: addicted) consumer and you have a business with the pricing power to defend revenue even in the face of a modestly declining market.

While the tobacco market is declining in the U.S., tobacco usage around the world continue to thrive particularly in Asia. A smart bet for one looking to play the industry is probably a paired buy of an industry leader in the United States - Altria ((MO), 50% share), Reynolds America ((RAI), 29%), or Lorillard (LO), 11%) - and a higher growth tobacco business either an internationally positioned business like Phillip Morris (PM) and British American Tobacco (BTI).

Another interesting route to hedge out risk to one of the oligopolistic leaders is to look for other marginal players who offer other kinds of differentiated tobacco products. One particular stock of interest is Star Scientific (STSI), a maker of “healthier” tobacco products. Its stock has actually tripled over the last year.

Me? Well, being the yield hog that I am. I’ve picked up a few shares of Altria while I work out my on going “tobacco strategy.” An 8% dividend yield and a share price that completely discounts any growth in free cash flows - dividends seems reasonable to me. Yes, there’s debt on the balance sheet but this is a cash cow which should service its debt handily for quite some time.

Full Disclosure: Author is long shares of MO at the time of writing.

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Comments

[107Sid:]

What about Vector Group? DDigit yield, dividends covered by cash flow, although not by reported earnings as has been the case for years. In addition holders have received a 5% annual stock dividend each September while maintining its $0.40 per share quarterly dividend payment, in effect increasing the cash dividend by 5% a year.

Apr 02 09:29 AM

[SJD:]

107Sid's points are well taken. In addition, VGR produces low cost product options for those smokers who opt to go that route when the tax on tobacco goes up.

Apr 02 09:55 AM

[notsosmart:]

since its all smoke & mirrors you might as well benefit by the smoke although im not sure about the mirror.

Apr 02 10:24 AM

[Dividend Gr...:]

I like and own PM ad MO..Tobacco is nice to own in a diversified portfolio consisting of other dividend paying representatives of other sectors. Otherwise a rapid change in the industry might leave you without a nest egg and dividend income. Just ask investors who were overweight financials in 2008 ...

Apr 02 10:26 AM

[Smokinhot:]

I personally enjoy my $3.40 Div from RAI on a $38 price point. The interesting upside on the tobaccos is the marijuana legalization play. The talk is that alcohol and tobacco consumption get diluted and reduced if marijuana gets legalized or further decriminalized. On the other hand, with weed legalization, maybe tobacco becomes a gateway drug to marijuana - a rejuvenation, eh? Or maybe even big tobacco gets into the commercial marijuana business themselves and some actual growth accrues to the tobacco bottom lines. Let's get creative folks.

Apr 02 10:30 AM

[secmaven:]

Tobacco kills from cancer! Do you really want to invest in a killer industry?

Apr 02 02:21 PM

[Smokinhot:]

It's more about personal freedom. If someone wants to kill themselves driving a car (more deaths from cars than tobacco) or smoking or cliff-diving or over-eating - then let's not let you dictate that YOUR narrow definition of "killer industry" is what the rest of us need to be concerned with. But thanks for your deep perception on the subject - I'll go and read up on this supposed cancer vs tobacco linkage.

Apr 02 03:30 PM

[reverse mor...:]

I certainly can't say my life has been free from tobacco, it has not, but I finally with the aid of hypnosis, nicorette, the patch (and whatever else I could throw in) conquered the habit. That does not however mean I'm not yearning for one right now.

I understand, though I've not yet looked in depth, that there is now an e-cigarette that is burning up the competition (excuse the pun).

These are troubled times (recovering yes) and turning to a cigarette to relieve stress is something that many, many people do. Whether or not it adds to their stress later in life, probably isn't a financial consideration (unless we're talking health care costs), but it sure is nice to breathe the fresh air and not taste cigarettes on my breath.

Apr 02 07:17 PM

[safetybob:]

I am yet to hear of a tobacco producer holding a gun on anyone forcing him or her to smoke a cigarette or anything else made of tobacco.

One has to remember that the freedom of choice, an American priveledge, continues even if the choice may have negative results.

Apr 02 10:51 PM

[wg:]

I smoked before any authorative body was saying it could kill you. I'd quit, go back, but I tell you this: nothing can make you quit smoking than a emt dr. saying, "Hey, I think I need to look down your throat." Made me quit. Gets your attention. But, you do what gives you pleasure. And I'd buy tobacco stock if it made money. Fools are fools.

Apr 02 11:46 PM

[Juliet:]

As an x-smoker I feel no karmic angst owning MO. That 8% yield is probably the only "settlement" I'll ever get...

Apr 03 01:53 AM

[Alex Lann:]

As I said before MO has a 19% compounded record since 1957. Altria's basic business is not cigarettes. Their basic business is acquisitions and spinoffs. Read Prof Jeremy Siegal's works to confirm. Altria is the most profitable company in history and is regarded by super conservative C. Allmon as being safe enough to be considered the same as the money market.

Apr 07 05:40 PM

[madmilker:]

"19% compounded record since 1957"....i didn't know tat...thanks Alex...

May 04 11:56 AM