Top Tobacco Stocks to Watch
Although morally reprehensible to many, there is no escaping the fact that tobacco stocks have a long history of providing shareholder value, particularly through the redistribution of excess cash. But with smoking in long-term decline, does investing in tobacco companies still make sense?
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Why Invest in Tobacco Stocks?
Tobacco companies have long been darlings of the stock market and have a reputation for treating their shareholders excellently.
However, it’s no secret, smoking is in decline, which has led to a long-term downward trend in tobacco share prices. Yet if you delve into the financial results of many tobacco companies, you’d be forgiven for not realising they sold a product with dwindling demand.
Due to the addictive nature of their product, tobacco companies have significant pricing power, allowing them to raise prices in order to offset falling consumption and, consequently, keep their margin intact.
Furthermore, well aware of falling demand for their flagship product, most cigarette manufacturers are pivoting towards non-cigarette products in order to prepare for a future where fewer people smoke.
Income Potential
Whilst there is optimism in the industry that next-generation products will spark strong future growth, the allure of tobacco stocks lies mostly in their income potential.
Cigarette companies tend to generate shedloads of cash, and have a long history of redistributing this cash amongst shareholders in the form of generous dividends. Indeed, many tobacco stocks can frequently be found in lists of top dividend paying stocks.
However, it should be noted that, whilst historic dividend pay-outs can be a useful indicator for investors, dividends are never guaranteed. If cash flows become restricted, the amount of money available to be returned to shareholders may fall, resulting in a dividend cut or even cancellation.
Top Tobacco Stocks to Watch
As competition for profit has intensified in recent years, consolidation has swept the industry, leaving just a few big international players. In the following sections, we will take a look at two top tobacco stocks for investors to watch in 2023.
British American Tobacco
British American Tobacco (BAT) is a UK-based tobacco company which operates around the world and is responsible for a variety of cigarette brands, including Lucky Strike and Camel.
BAT has begun pivoting away from cigarettes by investing in next-generation products. These new categories of products have experienced strong revenue growth, increasing 41% in full-year 2022, with BAT anticipating the division to be profitable by 2024, a year earlier than previously expected.
However, make no mistake, whilst the growth in non-combustible products is impressive, cigarettes remain the company’s bread and butter, accounting for 83% of total revenue in 2022. Whilst cigarette sales volume decreased year on year, revenue and operating profit both increased by 7.7% and 2.8% respectively, with net cash generated from operating activities also jumping 7%.
Subsequently, BAT raised their full-year dividend, something they have done every year for more than 20 years. At the time of writing, the cigarette company has a dividend yield of 7.2%.
However, despite the impressive cash generation, there was some cause for concern in BAT’s latest results. Adjusted net debt rose 7.3% to more than £38 billion. That is a lot of debt to have at a time when interest rates are elevated.
Altria Group
Altria Group is a US-based tobacco stock which counts amongst its products Marlboro, a cigarette which commanded a market share of 42.5% in 2022.
Unfortunately, unlike British American Tobacco, Altria’s attempts to diversify its revenue streams away from cigarettes have not gone according to plan. The company acquired a 35% stake in Juul – an electronic cigarette company – for $12.8 billion in 2018. However, in 2022, the Food and Drug Administration (FDA) banned Juul from marketing and selling its products in the US.
In the same year, Altria bought a 45% stake worth $1.8 billion in marijuana producer Cronos Group. Cronos is a publicly traded company and, after the deal was announced, it received a significant uplift in share price. This was, however, fairly short lived, with share price soon beginning to move downwards.
Altria acquired its stake in Cronos for around $12.17 a share – a 33% premium on the stock’s 30 November 2018 closing price – and, at the time of writing, Cronos is trading at around $2.30 a share.
Subsequently, Altria has been forced to write down billions on these two unsuccessful investments, which, unsurprisingly, soured sentiment amongst investors. But, failed diversification aside, the tobacco stock’s core business continues to perform robustly.
Again, we see a similar story as with BAT’s cigarette business. In 2022, smokable product sales volume dropped almost 10% year on year, and net revenue also fell by 2.3%. However, despite rampant inflation, costs fell, and operating income rose 3.1% for the year, with adjusted Earnings per Share (EPS) also rising by 5.0%.
Altria subsequently increased its dividend payout, the 57th time they have done so in the last 53 years, and announced a new $1 billion share buyback programme, highlighting management’s confidence in the business. At the current share price, the tobacco stock has a dividend yield of 8.0%.
How to Invest in Tobacco Stocks
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