{"id":38005,"date":"2013-04-30T12:38:03","date_gmt":"2013-04-30T16:38:03","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=38005"},"modified":"2013-04-30T12:38:03","modified_gmt":"2013-04-30T16:38:03","slug":"can-e-cigarettes-relight-big-tobacco","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/04\/30\/can-e-cigarettes-relight-big-tobacco\/","title":{"rendered":"Can E-Cigarettes Relight Big Tobacco?"},"content":{"rendered":"

By The Sizemore Letter<\/u><\/a> <\/p>\n

Has Big Tobacco stumbled into a new growth market in electronic cigarettes?<\/p>\n

Well, sort of.\u00a0 Use of e-cigarettes\u2014which produced a smokeless water vapor infused with nicotine\u2014is expected to more than double in 2013, which might ordinarily be good news for the major tobacco giants. Altria (NYSE:$<\/span>MO<\/a>)<\/b>, Reynolds American (NYSE:$<\/span>RAI<\/a>) <\/b>and Lorillard (NYSE:$<\/span>LO<\/a>) <\/b>are all active in the market or have concrete plans to be active.\u00a0 <\/b><\/p>\n

But the increasing popularity of e-cigs has come at the expense of the smoky originals.\u00a0 By Morgan Stanley estimates<\/a>, e-cigarettes replaced 600 million \u201cstick equivalents\u201d last year and will replace 1.5 billion in 2013.\u00a0 Varying estimates have e-cigarettes accounting for 0.5% to 1.5% of all cigarette sales.<\/p>\n

Growth is not something we\u2019ve come to expect from the tobacco industry.\u00a0 Yes, cigarette stocks have produced fantastic returns for investors in recent years, but these stock market returns have come even while unit cigarette sales have continued their drift lower.\u00a0 American cigarette sales fell by 6.2% last year<\/a> to 289 billion sticks; as recently as 2001, the number was well over 400 billion.<\/p>\n

What does this mean for Big Tobacco and its investors?<\/p>\n

The tobacco industry has been very effective at managing the economics of decline, much to the benefit of shareholders.\u00a0 Altria and Philip Morris International (NYSE:$<\/span>PM<\/a>)<\/b> were core holding of the Sizemore Investment Letter<\/a><\/i> for most of 2010 and 2011, and our readers enjoyed fantastic returns driven by the relentless search for yield by investors in the low-rate world of quantitative easing.<\/p>\n

There is absolutely nothing wrong with investing in an industry in decline, so long as the right conditions are in place.\u00a0 As I wrote last week (see \u201cAre Coke and Pepsi the New Big Tobacco?<\/a>\u201d<\/strong>), those conditions are:<\/p>\n

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  1. There should be substantial barriers to entry for new competitors.<\/li>\n
  2. The company should be financially healthy (i.e. strong balance sheet, low debt).<\/li>\n
  3. Management should be committed to rewarding shareholders via dividend hikes and\/or share repurchases.<\/li>\n
  4. The stock price should be cheap relative to the broader market.<\/li>\n<\/ol>\n

    How do e-cigs affect these criteria? \u00a0To start, they erode those all-important barriers to entry.<\/p>\n

    Outside of military armaments, Big Tobacco might be the most highly-regulated industry on the planet.\u00a0 <\/b>Though it sounds onerous, it\u2019s actually quite good for the large existing players because it makes it virtually impossible for new upstarts to come in and undercut the established brands on price.<\/p>\n

    There is one big problem here.\u00a0 The legal regime is still being formed for e-cigarettes, and right now it is something of a free-for-all that doesn\u2019t necessarily favor existing Big Tobacco.\u00a0 It varies from city to city or bar to bar, but e-cigs are also generally free of the indoor smoking restrictions that have helped to curtail tobacco use.<\/p>\n

    Would smokers be likely to pay a premium for an e-cigarette branded with the Marlboro label?\u00a0 Maybe.\u00a0 Maybe not.\u00a0 But I\u2019m betting the answer is no.<\/p>\n

    Rather than being a durable growth business for Big Tobacco, e-cigarettes seem to be yet another way to help people stop smoking\u2014a trendier version of a nicotine patch or Nicorette gum, if you will.<\/p>\n

    Patches and gum did not destroy the tobacco industry, and neither will e-cigarettes.\u00a0 But they may speed up its long-term decline.\u00a0 According to the Wall Street Journal<\/a><\/i>, e-cigarettes might have been a major reason that cigarette sales declined by over 6% last year rather than the usual 3-4%.<\/p>\n

    But in the end, the only aspect that matters to tobacco investors is how much of this is factored into current prices.\u00a0 Remember, item #4 above\u2014for an investment in an industry in decline to make sense, it has to be priced accordingly.\u00a0 And right now, Big Tobacco stocks actually trade at a slight premium to the broader S&P 500.<\/p>\n

    I could be wrong, of course.\u00a0 Rather than hasten the decline of traditional cigarettes, the e- variety may offer a real avenue for growth.\u00a0 But given how quickly the industry is shrinking, it is hard to see any growth of this front offsetting the declines in unit sales.\u00a0\u00a0 And none of the above justifies a premium multiple.<\/p>\n

    If you\u2019re looking for sustainable dividend growth at a reasonable price, Big Tobacco is not your best option at the moment.\u00a0 As I wrote earlier this year when I called semiconductor maker Intel (Nasdaq:$<\/span>INTC<\/a>)<\/b> my favorite \u201ctobacco stock,\u201d<\/a> you\u2019re a lot more likely to find value in Big Tech.<\/p>\n

    Sizemore Capital is long INTC.<\/p>\n

    SUBSCRIBE\u00a0<\/a><\/strong>to\u00a0Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n

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