3 Sin Stocks For High Returns

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Investors can select their stocks among several groups, based on their personal knowledge and their growth expectations for each category of stocks. Sin stocks are generally defined as those that sell tobacco, alcohol, or cannabis to their customers. Some stocks of this group offer exceptionally attractive dividends thanks to their strong pricing power, which results from the inelastic demand for their products. In this article, we will discuss the prospects of three tobacco stocks, namely Altria (MO), Philip Morris International (PM), and British American Tobacco (BTI), which are highly attractive right now.
 

Altria

Altria was founded in 1847 and has become a consumer staples giant. It is the producer of the top-selling cigarette brand in the world, namely Marlboro, as well as some non-smokeable products. Marlboro has maintained a market share of about 40% for several years in a row. Altria also has large stakes in global beer giant Anheuser Busch InBev (BUD), Juul, a vaping product manufacturer, and Cronos Group (CRON), a cannabis company.

Just like the other tobacco companies, Altria faces a secular headwind, namely the steadily declining consumption of cigarettes per capita. The consumption of cigarettes per capita has consistently decreased over the last three decades. On the other hand, Altria operates in a highly regulated industry, which virtually eliminates the threat of new competition. It also enjoys strong brands across its product portfolio, including the best-selling cigarette brand in the U.S. As a result, it has strong pricing power and brand loyalty. In addition, thanks to its economies of scale, Altria enjoys low manufacturing and distribution costs.

Thanks to the inelastic demand for its products, Altria has offset the declining consumption per capita with material price hikes year after year. It has thus exhibited an impressive performance record. During the last decade, Altria has grown its earnings per share every single year, at a 9.4% average annual rate.

Thanks to its impressive earnings growth trajectory, Altria has an exceptional dividend growth record. The tobacco giant has raised its dividend for 52 consecutive years and hence it is a Dividend King. The stock is currently offering an 8.2% dividend yield, with a payout ratio of 74%. While this payout ratio may seem high to some investors, it is a 10-year low for Altria, which has always targeted a payout ratio of about 80% thanks to its reliable cash flows. Overall, income-oriented investors should lock in the 8.2% yield of Altria before it falls to more reasonable levels.

The only caveat is the shift of the tobacco industry from traditional cigarettes to other products, such as vaping products. Altria has been caught somewhat off-guard in this transition. The tobacco giant acquired a 35% stake in Juul, a leader in vaping products, for $12.8 billion in late 2018 but the timing of the acquisition of the stake proved disastrous. Since the acquisition, Juul has incurred several hits due to restrictions from regulators. As a result, Altria has written off nearly all its investment in Juul.

However, it is important to note that Altria remains on its long-term growth trajectory. To be sure, the company grew its earnings per share by 6% in 2021 and has provided guidance for earnings per share of $4.79-$4.93 this year. At the mid-point, this guidance implies 5% growth, to a new all-time high. To cut a long story short, investors are given a rare opportunity to purchase Altria at a cheap valuation level thanks to the failed investment of the company in Juul, which is likely to prove just a temporary headwind.
 

Philip Morris International

Philip Morris International was formed when its parent company Altria spun off its international operations. Philip Morris sells cigarettes under the Marlboro brand and other brands in international markets.

Philip Morris has one of the most valuable cigarette brands in the world, Marlboro, and is a leader in the reduced-risk product category with iQOS. Thanks to its strong business position, it is generally a low-risk business. The only material risk comes from potential restrictions from regulators but Philip Morris is safer in this regard than many other tobacco companies thanks to its broad geographic diversification.

When the spin-off of Philip Morris was announced, the market assumed that Altria would be a low-growth company, given the relatively mature state of the U.S. market. However, Philip Morris proved to be a low-growth company. The earnings of the company have stagnated over the last nine years, with the tobacco giant on track to post approximately the same earnings per share this year as it did in 2013. The poor performance has partly resulted from a strong dollar, which reduces the earnings generated in international markets. The other reasons behind the poor performance are a leveraged balance sheet and the excessive investments of the company in new products in the last four years.

On the other hand, Philip Morris seems attractive right now. It has raised its dividend for 15 consecutive years and is currently offering a nearly 10-year high dividend yield of 5.5%. Its payout ratio is too high, at 96%, but the company is likely to be able to defend its dividend now that its past investments have begun to bear fruit and capital requirements have decreased sharply. Nevertheless, it is prudent for investors to be prepared for modest dividend raises going forward.
 

British American Tobacco

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 that it did not already own in 2017. Although the company is incorporated in the U.K., its dividend has no withholding tax for U.S. investors.

British American Tobacco operates in an oligopoly, which is characterized by the absence of price wars. The companies in this industry have always focused on profits over market share gains and thus profits have been rising for most tobacco companies. In addition, the demand for cigarettes is robust even under the most adverse economic conditions. This helps explain why British American Tobacco has performed well during recessions, including the Great Recession, in which its profits remained on the rise.

On the other hand, British American Tobacco has exhibited a more volatile performance record than Altria. The company has incurred a decrease in its earnings per share in some years, though this has been caused by a strong dollar in some years. British American Tobacco has grown its earnings per share by only 2.8% per year on average over the last decade.

On the bright side, the stock is currently offering a dividend yield of 7.2%. Given its healthy payout ratio of 65% and its resilient business model, its dividend should be considered safe for the foreseeable future. The only caveat is the adverse effect of a strong dollar on the dividend received by U.S. investors. However, the dollar currently stands at a multi-year high, and hence the currency effect on the dividend of British American Tobacco is unlikely to be negative in the long run.
 

Final Thoughts

Income investors are facing a perfect storm this year, as the surge of inflation to a 40-year high has triggered a bear market while it is also eroding the real value of the portfolios of investors. The above three sin stocks are attractive in the current investing environment, as their exceptionally high dividend yields largely offset inflation and make it easier for investors to wait patiently for the ongoing bear market to pass.


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Disclosure: The author does not own any of the stocks mentioned in the article.

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