Updated on August 5th, 2021 by Bob Ciura
As a business owner, selling products that have high profit margins along with strong brand awareness and an exceptionally loyal customer base is strongly desirable.
The tobacco industry fits this model, despite declines over time in the number of customers that use its products. Tobacco stocks are particularly attractive to income investors thanks to their generous dividends and defensive characteristics during economic downturns.
You can download a spreadsheet with all our tobacco stocks (along with important financial metrics such as dividend yields and price-to-earnings ratios) using the link below:
Tobacco stocks are widely prized by income investors thanks to their high dividend yields, stable payouts and dividend increase streaks. However, declining customer counts and usage rates are weighing on the group.
This article will analyze the prospects of 6 of the largest tobacco stocks. Rankings are in oder of projected total returns from worst to best.
Table of Contents
You can instantly jump to any individual stock analysis by clicking on the links below:
- Industry Overview: Declining Smoking Rates
- Philip Morris International (PM)
- Universal Corp. (UVV)
- Vector Group (VGR)
- Altria Group (MO)
- Imperial Brands plc (IMBBY)
- British American Tobacco (BTI)
But first, we’ll take a look at the tobacco industry’s primary concern, which is declining tobacco usage.
Industry Overview: Declining Smoking Rates
The percent of the U.S. population that smokes is in a continuous decline, and has been for decades.
Source: American Lung Association
The percent of the U.S. smoking adult population has steadily declined from 42% in 1965 to just 14% as of 2018. The declines among the youth population have been even bigger. Young people now have a smoking rate of about one in eleven. This sort of decline in an industry’s customer group generally spells trouble for the companies that operate within it.
Other forms of tobacco usage have seen similar rates of decline, including smokeless tobacco. This has been the case with every demographic group, so it is widespread among all of the companies’ potential customers.
Not only are fewer people smoking, but the ones that do are smoking less than they used to.
Source: American Lung Association
The number of people smoking at least 15 cigarettes a day has plummeted in the past few decades. Today, the overwhelming majority of smokers use fewer than 15 cigarettes daily. In other words, there are fewer customers for the industry. And, the ones that remain are using fewer products. This has negatively impacted demand from two directions. This has led to much lower volumes of total cigarettes sold, producing a declining total to be split up among the various companies selling cigarettes.
An increasing number of U.S. states have significantly raised the tax on cigarettes to reduce their budget deficits. Given the appeal of tax increases on cigarettes, the situation will likely only get worse for tobacco stocks.
In addition, pricing increases have the impact of reducing usage further. Demand will almost certainly continue to decline as taxes and prices rise. Indeed, health organizations like the American Lung Association actively encourage localities to raise taxes on cigarettes and other tobacco products to discourage usage.
To make matters worse for tobacco companies, most of the world’s smoking population rate looks much the same as the above chart. It has become abundantly clear that consumers around the world are eschewing tobacco products for health concerns.
These negative trends have kept many investors away from tobacco stocks. However, tobacco stocks can still generate solid total returns given that they tend to offer respectable dividend yields. The key behind an investment in tobacco stocks is the inelastic demand for cigarettes relative to their price due to the addictive nature of these products.
Tobacco companies have been able to raise their prices to help offset declining smoking rates. As a result, they have exceptional growth records. In addition, population growth partly offsets the effect of the declining percent of smokers. However, investors must keep in mind that the total volumes for the industry are in fairly steep decline.
Tobacco Stock #6: Philip Morris International (PM)
- 5-year expected returns: 5.6%
Philip Morris International was spun off from Altria in 2008, and is charged with the production and distribution of Altria’s products outside of the United States. This distribution includes the exceedingly valuable Marlboro brand.
Philip Morris is a large-cap stock with a sizable market capitalization of $155 billion.
On July 20th, 2021, Philip Morris reported Q2 2021 results for the period ending June 30th, 2021. For the quarter the company reported net revenue of $7.59 billion, which was up 14.2% compared to Q2 2020. Shipment volume was up 6.1% collectively, with cigarette shipment volume up 3.2% and heated tobacco, a much smaller portion of the business, up 30.2%. Adjusted earnings–per–share equaled $1.57 compared to $1.29 in Q2 2020.
Philip Morris authorized a new $7 billion share repurchase program, with target spending of $5 billion to $7 billion over a 3–year period beginning in Q3 2021. In addition, the company updated its 2021 full–year forecast, now anticipating $5.97 to $6.07 in adjusted earnings–per–share, up from $5.95 to $6.05 previously.
A potential game-changer for the company is the expansion of IQOS in new markets. Philip Morris has increased its capital expenses in the last two years in order to develop and manufacture this new product. IQOS has met great success in some markets, such as Japan and Korea.
This has helped the company grow its sales meaningfully in recent quarters, even though the volumes of traditional cigarettes have declined. The company recently surpassed 20 million IQOS users.
Source: Investor presentation
Interestingly, Philip Morris has a stated corporate goal of switching all of is users from tobacco products to some sort of smoke-free alternative over time. We are more cautious at 3% projected annual earnings growth.
Philip Morris currently offers an attractive 4.8% dividend yield. The stock is trading at a price-to-earnings ratio of 16.6, which is above our fair value estimate of 15.
On the other hand, thanks to the promising prospects of IQOS, the company has a positive growth outlook. In addition, shareholders receive a generous dividend while waiting for the growth expectations to materialize.
These factors mean Philip Morris could produce 5.6% total annual returns in the next five years, making it the least-attractive tobacco stock in our coverage universe.
Tobacco Stock #5: Universal Corporation (UVV)
- 5-year expected returns: 5.8%
Universal Corporation is the world’s largest leaf tobacco exporter and importer. The company is the wholesale purchaser and processor of tobacco that operates as an intermediary between tobacco farms and the companies that manufacture cigarettes, pipe tobacco, and cigars.
The company reported its fiscal fourth quarter and fiscal 2021 financial results in late May. Revenue of $620 million for the fourth quarter declined 2% year-over-year, due to lower leaf tobacco volumes, as some purchases had been moved forward to previous quarters. Fourth-quarter adjusted earnings-per-share of $2.15 rose 36% year-over-year. Full-year adjusted EPS was $4.25.
Source: Investor Presentation
As the leader in a declining industry, we do not expect the company to deliver strong business growth in the future. The company’s earnings-per-share could still rise over the next couple of years, however. Universal’s shares trade at a moderate valuation based on the earnings and cash flows that the company generates.
Universal also does not need to invest large amounts of money into its business, which gives it the ability to utilize a substantial amount of its free cash flows for share repurchases and dividends.
And, for its part Universal is attempting a transition to a producer of fruits, vegetables, and ingredients which the company hopes will diversify its business and provide renewed growth. Universal acquired FruitSmart, an independent specialty fruit and vegetable ingredient processor. FruitSmart supplies juices, concentrates, blends, purees, fibers, seed and seed powders, and other products to food, beverage and flavor companies around the world.
It also acquired Silva International, a privately-held dehydrated vegetable, fruit, and herb processing company. Silva procures over 60 types of dehydrated vegetables, fruits, and herbs from over 20 countries around the world. Therefore, Universal has the most diverse business model of the major tobacco stocks.
With a dividend payout of ~72% for the current fiscal year, we view Universal’s dividend as moderately safe, with the caveat that the company faces headwinds due to the steady decline of the tobacco industry.
The stock is now trading at 11.5 times this year’s earnings estimates, which is just slightly above its 10-year average price-to-earnings ratio of ~11 (which is also our fair value P/E). Given this, the stock could generate total returns of 5.8% per year, as the 6.2% dividend yield and EPS growth will be somewhat offset by a declining valuation.
Tobacco Stock #4: Vector Group
- 5-year expected returns: 8.9%
Vector Group is an unusual combination of a real estate investment firm and a tobacco company. The latter was founded in 1873 and continues to operate today as the Liggett Group, while the real estate business came later. Vector generated over $2 billion in 2020 revenue.
Source: Investor presentation
Vector Group has exhibited a volatile performance record and has failed to grow its earnings-per-share meaningfully over the last decade. While its earnings have remained essentially flat in the last eight years, the company has increased its share count by more than 30% over this period. Therefore, it is prudent to keep growth expectations at a minimum for this company on a per-share basis, as near-constant dilution has taken its toll.
Vector Group had previously paid a regular cash dividend of $1.60 per share and a 5% stock dividend annually through 2019. But its earnings and net operating cash have not covered the dividend in recent years. The company needed to borrow and use debt to pay the dividend.
The regular dividend was cut for 2020 and is now $0.80 per share and the stock dividend was suspended as well. Notably, the current cash dividend of $0.80 is still not covered by earnings or cash flow. But the company has a reasonable cash position and has recently retired the 5.5% Variable Interest Convertible Notes due in 2020 so no long–term debt is due until 2025.
Related: 3 Reasons Why Companies Cut Their Dividends (With Examples)
The only appealing feature of Vector Group is its 5.6% dividend yield. Such a yield may be sufficient to entice income investors. However, investors should note that the dividend payout ratio currently stands at about 114% for 2021, which is still unsustainable. Given that the payout was cut in half earlier this year, this payout ratio is all the more unattractive, as it seems there is a risk for another cut unless EPS increases above the dividend payout.
While the company has managed to maintain a payout ratio above 100% for the last decade, investors should not base their investing thesis on the ability of the company to maintain such high payout ratios in future years.
Shares trade at 20.5 times our earnings-per-share estimate for this year, which is slightly above our fair value of 20. Taking the 5.6% yield and earnings growth of 3% into account, we estimate total annual returns of 8.9% for the next five years for Vector stock.
Tobacco Stock #3: Altria Group (MO)
- 5-year expected returns: 9.7%
Altria is the market leader in American tobacco stocks. Before 2003, the company was known as Philip Morris, but was renamed as Altria after restructuring (including the aforementioned spin-off of Philip Morris International in 2008).
The company owns many well-known brands, including Marlboro, Skoal and Copenhagen. Altria still derives the overwhelming majority of its revenue and profits from smokeable tobacco, but the company also recognized years ago that smoking rate declines would likely continue.
To that end, it has been very busy remaking itself for the industry challenges it knew it would face. Altria reported second quarter earnings on July 29th. Revenue increased 9% to $6.9 billion, or 11% growth after excise taxes. The core smokeable products segment generated 8% revenue growth, driven by higher prices and volume growth.
Source: Investor Presentation
Adjusted earnings-per-share for the company came to $1.23, up 13% year-over-over year.
The long-term future is cloudy for cigarette manufacturers such as Altria, which is why the company has invested heavily in adjacent categories to fuel its future growth.
The company purchased a 55% equity stake in Canadian marijuana producer Cronos Group, invested nearly $13 billion for a 35% equity stake in e-vapor manufacturer Juul Labs, and recently acquired the remaining 20% ownership stake in Switzerland-based Burger Söhne Group it didn’t already own, for its on! oral nicotine pouch brand.
Related: The Best Marijuana Stocks: List of 140+ Marijuana Industry Companies
It has also invested in its own heated tobacco product line called IQOS, which the company continues to expand.
Altria is the market leader in the US cigarette industry. Market shares for large cigarette brands are relatively stable due to advertising restrictions; Marlboro remains the #1 brand in cigarettes today with over 40% domestic retail share.
This is an impressive record, particularly given the aforementioned decline in the percent of the U.S. smoking population. Its extraordinary performance is a testament to the strength of the business model of Altria and the reliability of its cash flows.
Altria is one of just 32 Dividend Kings, an exclusive group of stocks with 50+ consecutive years of dividend increases.
Altria has largely been able to offset smoking declines with price hikes. And, as its volume sales have decreased, its production cost has decreased as well. While Altria has an uphill climb in front of it, it appears conditions are improving.
The company enjoys extremely strong free cash flow. As a result, almost all of the company’s operating cash flows end up as free cash flow. Thus, almost all earnings are available for shareholder distributions.
This is the exact type of business model that Warren Buffett looks for; companies that need minimum capital expenses and thus enjoy strong free cash flows. Thanks to this strength, Altria pursues a dividend payout ratio around 80% and its management has confirmed that it will continue to distribute about 80% of adjusted earnings in dividends.
With ~2% expected EPS growth, and a 7.3% dividend yield with a small boost from an expanding P/E multiple, we expect nearly 10% annual returns for Altria stock over the next five years.
Tobacco Stock #2: Imperial Brands plc (IMBBY)
- 5-year expected returns: 9.8%
The next stock on our list is Imperial Brands, a British tobacco product conglomerate that was founded in 1901. Today, the company is a market leader in a variety of locations around the globe and produces nearly $12 billion in annual revenue.
Source: Investor presentation
Imperial Brands reported first half results for fiscal 2021 on 5/18/2021. Net revenue improved 3.5% in constant
currency. Tobacco revenues grew 3.2% despite a 3.3% decline in volumes.
Adjusted earnings–per–share increased 7% in constant currency. Total tobacco market share increased 70 and 40 basis points in the U.K. and Spain, respectively, but was partially offset by a 40–basis point contraction in Germany. Cigarette market share growth improved once again in the U.S. and Saudi Arabia.
Imperial Brands expects to grow EPS at a mid–single digit growth rate in fiscal 2021. We continue to expect earnings–per–share of $3.46 for fiscal 2021.
Imperial’s dividend yield is quite robust although last year it cut its dividend by approximately 33%. Still, the stock yields 8%.
Separately, the stock is trading for a relatively low multiple of earnings, and Imperial, like many of the other companies on this list, converts an enormous amount of revenue into free cash flow.
Our estimate for this year is $3.46 in earnings-per-share, and shares trade for just 6.3 times that number. That is just below our assessed value of 6.5 times earnings. Coupled with 3% expected EPS growth per year and the ~8% dividend yield, Imperial could return over 11% annually to shareholders in the coming years.
Tobacco Stock #1: British American Tobacco (BTI)
- 5-year expected returns: 13.1%
British American Tobacco is one of the largest tobacco companies in the world, with a market capitalization of $81 billion. British American Tobacco owns the following tobacco brands, among others: Kool, Benson & Hedges, Dunhill, Kent, and Lucky Strike.
In July 2017, the company acquired the remaining 48% stake in Reynolds American Tobacco that it did not already own. This cemented its competitive position as one of the world’s largest tobacco companies.
Although the company is incorporated in the United Kingdom, American investors can purchase its stock through American Depository Receipts. The ADRs trade on the New York Stock Exchange under the ticker BTI. The United Kingdom does not impose a dividend withholding tax on United States investors.
British American Tobacco has grown its earnings-per-share at a ~5% average annual rate over the last decade. However, most of this growth came in the early part of the decade. Indeed, from 2013 to 2018, earnings-per-share growth averaged just 1% annually.
itish American Tobacco announced its most recent trading update, the UK equivalent to quarterly results, on June 8. BTI’s trading updates do not include specific earnings numbers, but they tell investors about the performance of the company during the last couple of months.
The company’s portfolio of new, non-combustible products is leading the way.
Source: Investor Presentation
The company recently unveiled its half-year report. Adjusted revenue and adjusted earnings-per-share increased 8.1% and 6.1%, respectively. Combustible product revenue increased 5.8%. Growth in the New Categories segment (which includes vapor, heated tobacco and modern oral products) increased 50% in constant currencies.
For the full year, BTI expects the global tobacco industry volume to be down 1.5%. Meanwhile, U.S. industry volume is expected to decline 5.5%. Still, BTI expects full-year constant-currency revenue growth above 5%. The company also expects mid-single-digit adjusted EPS growth. This growth will largely be due to New Categories.
This level of adjusted EPS should cover the company’s dividend payment, which currently yields nearly 8%.
Given the payout ratio of 62% expected for 2021, the dividend seems to be fairly safe. The current yield is excellent at nearly 8%.
Shares trade for just 7.8 times this year’s earnings. This is meaningfully lower than our fair value estimate of 9.5 times earnings. Overall, we feel that the market has overreacted in the case of British American Tobacco.
We expect 13.1% annual returns over the next five years, making BTI our top pick among tobacco stocks.
Final Thoughts
Tobacco stocks as a group have had a difficult time in the past couple of years. Regulatory and consumer preference changes continue to plague the group. But valuations are low, dividend yields are high, and some companies are diversifying away from tobacco. BTI now offers the best total projected annual returns, but several of these companies offer high dividend yields.
We see Altria, Imperial Brands, and British American Tobacco as offering the best total returns. And, all offer sizable dividend yields. It appears that Vector’s dividend is the least secure among the group, given its very high payout ratio. But overall, there is a lot for income investors to like when it comes to these 6 tobacco stocks.