Is Big Tobacco Running Out of Options?

Until recent years, investors loathed tobacco stocks and could quickly list a number of obvious problems the companies faced: lawsuits, smoking bans, higher taxes, more people quitting… As a result, there were decades when these unloved stocks traded at low valuations, delivered high yields, and produced growing cash flows that were used to further reward shareholders.

In the last 5-6 years, these stocks have become investor darlings as people reached for yields and discovered consumer stocks, tobacco in particular, produced solid shareholder yield. Tobacco companies were among some of the strongest stocks in the indices to start 2017.

Unfortunately, actual growth for these companies has largely vanished at the same time investors piled into them as they chased high dividends at high valuations with little room to withstand new problems that arise. For example, Altria Group (MO) paid 125% of free cash flow for their dividend in 2017 and British American Tobacco (BTI) paid 86%.

We are going to focus on the US market because that is where much of the attention has been. As noted in this April 2017 WSJ article, the narrative of the US tobacco market has flipped as it now faces a rosier future. In the past, these companies had problems in that it was widely known they faced negative growth as more people stopped smoking. They have countered  these  problems by consolidating, cutting overhead costs, and borrowing money to repurchase shares.

As those cards have been played, there is increasingly less left in the financial quiver to let them mask the decay. Read the rest of the article here…