{"id":40321,"date":"2013-07-24T14:43:56","date_gmt":"2013-07-24T18:43:56","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=40321"},"modified":"2013-07-24T14:43:56","modified_gmt":"2013-07-24T18:43:56","slug":"should-tobacco-investors-fear-the-fda","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/07\/24\/should-tobacco-investors-fear-the-fda\/","title":{"rendered":"Should Tobacco Investors Fear the FDA?"},"content":{"rendered":"

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

The US Food and Drug Administration announces it is considering banning or strictly regulating menthol cigarettes<\/a>\u2026and the share prices of the companies that make and sell those menthol cigarettes take a tumble.\u00a0 Haven\u2019t we seen this movie before?<\/p>\n

Midday Tuesday, the share prices of Altria ($<\/span>MO<\/a>), Reynolds American ($<\/span>RAI<\/a>) <\/b>and Lorillard ($<\/span>LO<\/a>)<\/b> were down by 2.8%, 1.9% and 4.1%, respectively, on the news that the FDA was considering stiffening the regulation on menthol-flavored cigarettes.\u00a0 Apparently, despite decades of anti-smoking educational campaigns and prohibitively expensive taxation in many American cities, the flavored cigarettes encourage non-smokers to pick up the habit.\u00a0 Who knew.<\/p>\n

Lorillard took a bigger beating from the market than Altria or Reynolds American because menthol-flavored cigarettes make up a much bigger chunk of sales.\u00a0 Newport\u2014Lorilard\u2019s premium menthol-flavored brand\u2014is the top selling menthol brand and the second-largest-selling cigarette brand overall.<\/p>\n

Should investors be concerned about this?<\/p>\n

I wouldn\u2019t worry too much about a menthol ban, per se.\u00a0 We went through this same song and dance back in 2011.\u00a0 The FDA made noise about banning or strictly regulating menthol cigarettes, which depressed Lorillard\u2019s stock price\u2014and created the conditions for one of the best trades of my career<\/a>.\u00a0 The FDA\u2019s case\u2014that menthol-flavored cigarettes taste better and thus encourage more people to smoke\u2014is a weak one.\u00a0 By the same logic a screwdriver should be illegal because the orange juice masks the taste of the vodka.\u00a0 It\u2019s hard to see something like this holding up in court.<\/p>\n

But don\u2019t mistake my downplaying of the risk of anti-menthol regulations for bullishness on tobacco stocks.\u00a0 The last \u201cmenthol scare\u201d created a fantastic investment opportunity in Lorillard shares because it made them fantastically cheap.\u00a0 They traded for less than 12 times earnings and yielded nearly 7% in dividends.\u00a0 Today, Lorillard changes hands at 15 times earnings and yield a much less impressive 4.7%.\u00a0 Altria and Reynolds American sport earnings ratios that are considerably higher\u2014and higher than the S&P 500 average\u2014while also yielding about the same as Lorillard in dividends.<\/p>\n

And while I believe this menthol scare will pass, there are other regulatory challenges that are likely to linger for a while\u2014including the move to plain packaging.<\/p>\n

I wrote last week<\/a> that plain packaging laws attack Big Tobacco\u2019s most valuable asset:\u00a0 its companies\u2019 brands.<\/p>\n

Cigarettes in Australia now come in plain boxes with identical plain-type fonts on the front and grotesque pictures of cancerous death on the back; no logos or branding is allowed.\u00a0 Aussie smokers have complained that their cigarettes now \u201ctaste different,\u201d and early indications are that the rules are reducing cigarette consumption at the margin.\u00a0 Most of the developed world is considering implementing similar plain-packaging rules.<\/p>\n

Does this mean imminent death for Big Tobacco?\u00a0 Of course not.\u00a0 This is an industry that has survived decades of regulatory attacks and lawsuits and yet still goes about its business profitably.\u00a0 But at the margin, plain packaging rules will erode the value of Big Tobacco\u2019s business.<\/p>\n

Tobacco stocks have had a great run over the past decade, beating the market on a total return basis by a wide margin.\u00a0\u00a0 But that outperformance was made possible by their cheap valuations and astronomically high dividend yields, and these conditions are not in place today. \u00a0\u00a0If you want to buy Big Tobacco for its still higher-than-average dividend payouts, be my guest.\u00a0 But be realistic and don\u2019t expect the same kind of outperformance going forward.<\/p>\n

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

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