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3 Tobacco Stocks to Watch Despite Industry Headwinds

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Stern regulatory norms and limitations have been a cause of worry for several players in the Tobacco industry. Also, hurdles associated with the pandemic, such as soft duty-free sales due to limited international travel have been a concern. That said, strong pricing power has been an upside.

Apart from this, focus on reduced risk products (RRPs) or smoke-free alternatives has been working well for companies like Philip Morris International Inc. (PM - Free Report) , Altria Group, Inc. (MO - Free Report) and 22nd Century Group, Inc. (XXII - Free Report) .


About the Industry

The Zacks Tobacco industry includes companies that manufacture and sell cigarettes as well as tobacco and nicotine-based products such as cigars, snuffs and oral tobacco. Some of the companies also offer reduced-risk products such as e-cigarettes, vaping and heat-not-burn variants. A few of the firms are also engaged in making devices and attachments needed in vaping and heat-not-burn products. Most of the products manufactured by the tobacco industry participants fall under the strict vigilance of the U.S. Food and Drug Administration (FDA) and are required to follow the permissible levels of nicotine in manufacturing. Players in this space sell products mostly through large retailers, distributors, convenience stores, drugstores, wholesalers and grocery chains. Additionally, some of the international tobacco firms operate in the country through subsidiaries.

4 Trends Shaping the Future of Tobacco Industry

Stern Government Regulations: Cigarette volumes are being affected by strict government regulations pertaining to sales, marketing and manufacturing. Such regulatory norms are imposed due to the health hazards caused by the consumption of nicotine. Some of the guidelines issued by the FDA include mandatory use of precautionary labels on cigarette packets and self-critical advertisements. Moreover, campaigns against tobacco consumption have led to increased consumer awareness, which has, in turn, resulted in lower smoking rates. Since cigarette sales account for the majority of revenues for companies in the tobacco industry, dwindling sales volumes in this category is a concern. Many consumers have also switched from cigarettes to other smoke-free options. In the reduced risk products or RRPs space, the IQOS was a big hit. However, on Nov 29, 2021, an importation ban and cease-and-desist order were imposed by the U.S. International Trade Commission (ITC) concerning IQOS Platform 1 products. These include consumables and infringing components. Consequently, IQOS is currently not available for sale in the United States. Such regulatory pressures raise revenue concerns for industry players.

Pandemic-Led Adversities: Soft duty-free business stemming from reduced traveling amid the pandemic has been weighing on cigarette sales volumes of some tobacco companies. Apart from this, the risk of serious lung diseases related to the virus keeps consumers somewhat cautious about smoking.

High Pricing a Major Upside: Companies in the space have been gaining from the solid pricing power of tobacco products, which also help them make up for high taxes and sometimes even lower cigarette sales volumes. As smokers don’t mind a price hike due to their addiction, this strategy is likely to keep working for players in the tobacco space. High pricing of cigarettes has been supporting revenues and operating income of some of the players in the tobacco industry.

Low-Risk Products Gain Prominence: Low-risk tobacco alternatives, also referred to as next-generation tobacco products, have been gaining immense popularity. As compared to cigarettes, these products are claimed to be less detrimental to health owing to their scientific composition and manner of use. Consumers are increasingly taking to such products in a bid to quit cigarettes. Tobacco biggies have been witnessing substantial revenue growth in the RRPs arena. The companies are making investments to expand in this category, such as undertaking innovations to make these products user friendly and energy efficient. The performance of tobacco players is expected to continue benefitting from RRPs. That said, the FDA is keeping a close tab on the manufacturing and marketing policies of such items to regulate their usage among the youth.

Zacks Industry Rank Indicates Drab Prospects

The Zacks Tobacco industry is housed within the broader Zacks Consumer Staples sector. The industry currently carries a Zacks Industry Rank #227, which places it in the bottom 8% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since the beginning of December 2021, the industry’s earnings estimate for 2022 has declined 1.2%.

Let’s take a look at the industry’s performance and current valuation.

Industry Vs. Broader Market

The Zacks Tobacco industry has outperformed the Zacks S&P 500 composite as well as the broader Zacks Consumer Staples sector over the past year.

The industry has gained 24.4% over this period compared with the broader sector’s growth of 6.4%. Meanwhile, the S&P 500 has risen 12.3% in the said time frame.

One-Year Price Performance



 

Industry's Current Valuation

On the basis of forward 12-month price-to-earnings (P/E), which is commonly used for valuing consumer staples stocks, the industry is currently trading at 12.41X compared with the S&P 500’s 19.42X and the sector’s 20.17X.

Over the past five years, the industry has traded as high as 21.24X, as low as 9.16X and at the median of 11.57X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)

3 Tobacco Stocks to Keep a Close Eye on

Philip Morris International: The company is one of the industry pioneers in driving the shift from cigarettes to RRPs. The company is committed to expanding these products to more markets. It has also been making radical progress in the respiratory drug delivery platform, as part of the “Beyond Nicotine" strategy. Moreover, this Zacks Rank #3 (Hold) company has long been benefiting from its strong pricing of tobacco products.

Shares of Philip Morris have gained 29% in a year. The Zacks Consensus Estimate for PM’s 2022 earnings per share or EPS has risen by a cent in the past seven days.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: PM

Altria Group: The company has a robust portfolio of cigarettes, RRPs and oral tobacco products. It has also undertaken efforts to expand in the cannabis industry. Moreover, Altria, with a Zacks Rank #3, has been on track with the expansion of its oral tobacco products. The company, through its subsidiary Helix Innovations, has full global ownership of on! — a popular tobacco-derived nicotine (TDN) pouch product. Apart from these, consistent gains from higher pricing have been supporting the company’s revenues.

Altria’s shares have gained 16.5% in a year. The Zacks Consensus Estimate for MO’s 2022 EPS has increased by a cent over the past 30 days.

Price and Consensus: MO

22nd Century Group: The plant biotechnology company is focused on technologies that change the nicotine level in tobacco plants, as well as the cannabinoids level in hemp/cannabis plants. 22nd Century Group’s commitment toward its goal of lowering smoking-related damages by offering reduced nicotine tobacco cigarettes has been yielding well. Increased contract manufacturing sales have been driving this Zacks Rank #3 company.

The Zacks Consensus Estimate for 22nd Century Group’s 2022 EPS has been stable over the past 30 days. Shares of XXII have declined 47.7% in a year’s time frame.

Price and Consensus: XXII



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