Tobacco Companies Get a Clear Smokeless Signal
Traditional cigarette sales have been resilient in the Covid-19 crisis, but investors seem prepared to reward only innovation
The weak performance of most tobacco stocks this year suggests it will be a slog to lose their pariah status. A rally in one outlier, Swedish Match, SWMA +0.42% shows why it should be worth the effort.
Shares in the Stockholm-listed business, which makes smoke-free nicotine products like Zyn oral pouches, have gained 50% this year. Its valuation premium over tobacco giants Philip Morris International, PM -0.54% British American Tobacco BTI -2.12% and Altria MO 0.25% in terms of forward price-earnings multiples has grown correspondingly more extreme.
Among investors, there seems to be pent-up demand for a certain type of nicotine hit. Swedish Match makes more than 60% of its sales from smokeless tobacco products that have lower health risks than traditional cigarettes and don’t face the same regulatory burdens.
Traditional tobacco companies have reported resilient sales and profits this year, but their stocks have proven less defensive than during the last economic downturn. From the beginning of 2008 to the end of 2010, BAT and Altria outperformed the S&P 500. This year, the big listed tobacco stocks are still down 10% to 20%, while the U.S. index has risen.
Even with companies in other sectors slashing dividends, few stock pickers have been tempted by tobacco stocks’ high payouts. Altria, BAT and Philip Morris offer an average dividend yield of 7.8%—four times the S&P 500 average. But investors are more focused on hawkish regulation in the U.S., the threat of cigarette substitutes like vape pens and the health impact of smoking as environmental, social and governance concerns become a top Wall Street priority.
Tobacco companies have been spending heavily on more socially acceptable smokeless products for years now. The big debate for investors might be at what point such innovations can make the stocks more socially acceptable. Swedish Match’s shares really started to make gains in 2018, when just under half its business was smokeless.
There is no need to clean up portfolios entirely. Swedish Match still makes 30% of its sales from combustible cigars. And for now it is only lucrative cigarette sales that can generate the billions of dollars in research and development funds being poured into new products.
Philip Morris International is closest to what might be the magic 50% mark: It wants up to 42% of its sales to be smoke-free by the middle of this decade. It has been rewarded with a superior stock-market valuation, also because it doesn’t sell traditional cigarettes in the U.S.
British American Tobacco is aiming for roughly one-fifth by 2025—double its current sales exposure—and has used the crisis to boost its e-commerce and online subscription business. Altria, which makes the Marlboro brand in the U.S., is farther behind after its disastrous $13 billion bet on vaping brand JUUL.
Tighter tobacco regulation may slip down governments’ to-do lists as they grapple with the economic problems caused by the pandemic and shift their attention to improving tax revenue. That could reverse the underperformance of cigarette stocks, at least temporarily. And sales in the global tobacco market are still expected to grow by 2.8% annually between now and 2024, Credit Suisse CS -0.19% estimates.
Even if consumers still want traditional cigarettes, though, it is becoming ever clearer that investors will reward companies that mainly sell something else.
