New York Mayor Taking On Big Tobacco (MO, RAI, PM, more)
Earlier this week, New York City Mayor Michael Bloomberg announced a proposal that would place restrictions on how stores across the city can display cigarettes and other tobacco products. Though the proposal brings up a whole slew of issues that could be debated, the main thing investors may worry about is how this might affect tobacco stock plays over the long-term.
Mayor Bloomberg has been on a mission to fight big tobacco for awhile now; he has personally spent $600 million on anti-smoking efforts across the world. This latest proposal follows the footsteps of similar laws in Iceland, Ireland, England, and Canada, but would be the first such legislative proposal in the US.
Bloomberg is looking to limit young people’s exposure to tobacco products in attempt to stop them from smoking. It is a sort of “out of sight, out of mind” idea to prevent kids from smoking. Though this proposal might not have much impact on tobacco companies in the short term, if Bloomberg’s plan passes and spreads across the county, it may have a slightly negative long term impact on tobacco stocks for investors to consider.
Nice Returns from Tobacco Stocks
Historically, tobacco stocks have been relatively stable investments, especially for dividend focused investors. Even in times of recession or economic downturn, tobacco stocks, and other “sinful stocks,” tend to buck the overall trend and remain stable in a bear market.
The reason for this attractive value play is that the tobacco industry sells a product with a relatively inelastic demand, meaning consumers will purchase the product no matter the price it is being offered. The addictive nature of tobacco products leads to a consumer that, for the most part, will buy no matter how much it costs. This results in a stable cash flow that allows the companies to pay out a healthy dividend that investors can take advantage of.
Dividend.com currently rates three tobacco companies as “Recommended.” Altria Group (MO), Reynolds American (RAI), and Philip Morris International (PM) all hold a DARS™ rating of 3.5 stars out of 5 stars due to attractive dividend yields and healthy growth rates. Even though Lorillard (LO), British American Tobacco (BTI), and Vector Group (VGR) are rated as “Neutral,” they still offer substantial over-5% dividend yields that might be appealing to investors. It just shows that tobacco industry plays have traditionally been kind to investors.
Even if Bloomberg’s proposal goes through and sweeps the country, the inelastic nature of the product could help these companies to maintain a substantial cash flow even though the volume of consumers declines. But it is unclear what the long term impact might be if Bloomberg’s mission to curb adolescent smoking actually succeeds.
The Bloomberg Effect
Let’s say Bloomberg gets his way and his proposal goes through. If the intended consequence unfolds, that fewer young people start smoking, it could mean that the domestic consumer base for tobacco companies may dwindle. While tobacco companies could push up prices to offset the fewer number of consumers, there may be a tipping point at which customers refuse to purchase their cigarettes; demand for cigarettes is inelastic, but not perfectly inelastic.
This could spell long-term trouble for tobacco companies. The resulting outcome would be that the companies see decreased earnings and limited cash flow. At this point the stable dividend payouts and stock growth rates may finally hit a wall.
However, a saving grace for the tobacco industry, and thus investors, is that consumers in emerging markets make up a growing portion of total revenues for these companies. Even if Western and other developed nations start to seriously crack down on tobacco usage, the cash flow from these developing markets could maintain earnings growth rates and dividend payouts. So while it seems like US policymakers are doing what they can to discourage the use of sin products like tobacco, the entire consumer base is still growing abroad.
The Bottom Line
Investors may be hesitant to invest in tobacco stocks due to their controversial industry; that’s understandable. However, it should be noted that positions in tobacco stocks can be a stable investment for any portfolio. While it may seem like policymakers, such as Michael Bloomberg, are seeking to diminish tobacco consumption, this cash cow is not ready to fade away just yet; the consumer base and demand for tobacco products is just too large. You don’t have to love or agree with the tobacco industry, but writing it off could lead to a missed opportunity in substantial investment returns.
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