Consumption of tobacco products per capita in developed countries has been slowly declining for several years in a row. However, thanks to the inelastic demand for these products, the major tobacco companies have been able to offset their declining volumes with material price hikes and thus they have been growing their earnings per share significantly.

Moreover, due to the headwind from regulatory authorities in many countries, which try to limit the consumption of tobacco products, tobacco stocks are trading at markedly cheap valuation levels right now.

Photo by Afif Kusuma on Unsplash

In this article, we will analyze the prospects of three highly attractive consumer staples stocks, which operate in the tobacco industry and have high yields with low valuations.

Altria (MO)

Altria is a consumer staples giant. It sells cigarettes, chewing tobacco, cigars, and e-cigarettes under the Marlboro brand.  The company has also tried to diversify away from its flagship tobacco products and thus it has a 10% equity stake in Anheuser-Busch InBev (BUD), a 35% stake in e-cigarette producer JUUL, and a 45% stake in marijuana company Cronos Group (CRON).

Nevertheless, Altria still generates the vast majority of its revenues and earnings from its smokeable tobacco products.

Despite the declining consumption per capita of tobacco products, Altria has grown its earnings consistently for decades thanks to the inelastic demand for its products, which has enabled the company to raise its prices at a fast pace. Altria has grown its earnings per share every single year over the last decade, at an 11.5% average annual rate. This is an impressive growth rate for a mature company whose sales volumes have been declining.

On the other hand, Altria has decelerated in the last three years due to the growing popularity of e-cigarettes and other products. Nevertheless, the tobacco giant has kept growing its bottom line, albeit at a slower pace.

In the third quarter, the total revenue of Altria declined 4.7% due to a 5.4% decrease in the revenue of smokeable products. Nevertheless, thanks to wider margins and some share repurchases, the company grew its adjusted earnings per share 2.5% over last year’s quarter. Even better, it is on track to grow its earnings per share 6% this year, to a new all-time high.

Going forward, Altria has invested heavily in alternative products, via its 35% stake in JUUL and its $1.8 billion investment in Cronos. It is also trying to expand the reach of its own e-cigarette brand IQOS. These initiatives are likely to be significant growth drivers in the upcoming years. Nevertheless, due to the deceleration of Altria in recent years and the transitional phase of this business, it is prudent to expect Altria to grow at a much slower pace than its historical growth pace.

On the other hand, the above headwinds have weighed on the stock and hence Altria is currently trading at a price-to-earnings ratio of only 9.7 and is offering an abnormally high dividend yield of 8.0%. The tobacco giant has raised its dividend 56 times in the last 52 years. Given also its reasonable payout ratio of 78%, which is in line with the historical average payout ratio of the stock, and its decent growth prospects, the dividend is safe for the foreseeable future.

British American Tobacco (BTI)

British American Tobacco is one of the largest tobacco companies in the world. It owns many tobacco brands, including Kool, Benson & Hedges, Dunhill, Kent, and Lucky Strike. The company also acquired the remaining 48% stake in Reynolds American Tobacco, which it did not already own, in 2017.

Just like the other major tobacco companies, British American Tobacco is resilient to recessions. The company has proved its defensive character throughout the coronavirus crisis. In 2020, which was marked by unprecedented lockdowns and a fierce recession, British American Tobacco grew its earnings per share 5%, to a new all-time high. Given the nature of the downturn, which led people stay at home more than ever, the performance of British American Tobacco is certainly impressive.

Moreover, the positive momentum has remained in place this year. In the first half of the year, the company grew its revenue 8% over last year’s period, primarily thanks to a 50% increase in the revenue of reduced-risk products. British American Tobacco also grew its earnings per share 6%.

Moreover, British American Tobacco is offering an 8.0% dividend yield. Thanks to the solid payout ratio of 66% of the stock, its resilience to recessions, and its decent growth prospects, investors should rest assured that the generous dividend of the company will remain safe for the foreseeable future.

Vector Group (VGR)

Vector Group is a holding company that is an unusual combination of a cigarette company and a real estate firm. The company owns and controls two tobacco companies: Liggett Group and Vector Tobacco. Vector Group also owns New Valley, which is a real estate investment business. The Tobacco segment primarily sells discount cigarette brands, such as Eagle ’20s, Pyramid, Grand Prix, Liggett Select, and Eve. New Valley owns Douglas Elliman Realty, which is the largest real estate brokerage in New York City.

In the most recent quarter, Vector Group exhibited strong performance. Its net revenues jumped 65% over last year’s depressed level thanks to the recovery of the real estate business, whose revenue tripled over last year’s depressed level amid the pandemic. As a result, the company switched from a loss per share of -$0.08 to a profit per share of $0.27. Thanks to the continued recovery of its real estate business, Vector Group is poised to achieve record earnings per share this year.

In contrast to its peers, Vector Group has exhibited volatile earnings and was forced to cut its dividend by 50% at the onset of the pandemic. Moreover, the stock is offering a 5.1% dividend yield, which is attractive but much lower than the 8.0% dividend yield of the above two tobacco giants.

Final Thoughts

Tobacco stocks have fallen out of favor lately due to the efforts of some developed countries to limit smoking rates and the uncertainty that surrounds the ongoing transition towards reduced-risk products. As a result, the aforementioned stocks are trading at exceptionally cheap valuation levels, with markedly high dividend yields.

As soon as headwinds subside, the market will shift its focus on the advantages of tobacco stocks, which include weak competitive forces, reliable earnings growth, excessive free cash flows, and resilience to recessions. When that occurs, the above stocks will greatly reward their shareholders.