Why Tobacco Stocks Are Likely Poised For A Sharp Drop

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 |  Includes: MO, PM
by: Hawkinvest

Tobacco stocks have seen a very strong rally in 2012, but many stocks in this sector are starting to give back some of the gains, and there are at least two looming issues that could possibly erase even more of the gains for these stocks as the year progresses.

One big issue is that states are hungry for more tax revenues to help plug major deficits. Governor Jerry Brown is counting on Prop. 29 in California to raise taxes by $1 per pack of cigarettes. That is a significant tax increase and as most realize, when you tax something, you will generally see reduced demand. Early election results shows that the proposition has passed, and it probably won't be the last attempt by a state to raise taxes on tobacco products. Some might say taxes have not been too harmful for cigarettes, but an extra $1 per pack in a weak economy is likely to reduce demand.

The other issue is that the tax rate on dividends could be poised to nearly triple. With President Obama's 2013 budget and the surcharge for Obamacare, dividend taxes could nearly triple from 15% to as high as 44.8%. These major issues could be enough to take tobacco stocks lower and possibly erase the gains enjoyed in 2012.

Here are two stocks that investors should consider taking profits on now, or possibly even shorting:

Altria Group, Inc. (NYSE:MO) shares started the year out trading around $28 and even hit a new 52-week high recently at $32.14. However, it could be hard for the stock to hold those gains. This company makes popular brands such as Marlboro, Virginia Slims, Parliament, Benson & Hedges. It offers investor some diversification because it also makes wines with brands like Chateau Ste. Michelle and Columbia Crest. While this stock has been a favorite for some income investors, it might make sense to take profits now and patiently wait for better buying opportunities between $28 to $29 per share.

Here are some key points for MO:
Current share price: $31.80
The 52 week range is $23.20 to $32.62
Earnings estimates for 2012: $2.20 per share
Earnings estimates for 2013: $2.36 per share
Annual dividend: $1.64 per share which yields 5.2%

Philip Morris International (NYSE:PM) shares started the year around $73 and then went to about $90 in early May. However, the shares are already almost 10% below those highs and could be headed lower. This company is a global leader with brands like Marlboro, Merit, Parliament, Virginia Slims, L&M, Chesterfield, etc. With nearly $32 billion per year in annual revenues, this company is about twice the size of Altria Group. However, it faces the same potential challenges, which could include a wave of tax increases not just in California, but also in other states and globally. These issues plus the possibility of higher taxes on dividends could be enough to make the stock give back its gains for 2012. Investors should consider taking profits now.

Here are some key points for PM:
Current share price: $81.91
The 52 week range is $60.45 to $91.05
Earnings estimates for 2012: $5.26 per share
Earnings estimates for 2013: $5.83 per share
Annual dividend: $3.08 per share which yields 3.7%

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.