Players in the Zacks Tobacco industry have been bearing the brunt of the inflationary environment, which has affected Adult Tobacco Consumers’ (“ATC”) spending patterns. The cost inflation of direct materials has also raised margin concerns for companies in the space.

However, pricing power has been a major upside. Strength in the smoke-free product arena as a response to consumers’ changing preferences has also been working well for players. Such upsides keep Philip Morris International Inc. (PM Quick QuotePM - Free Report) , Altria Group, Inc. (MO Quick QuoteMO - Free Report) , Turning Point Brands, Inc. (TPB Quick QuoteTPB - Free Report) and 22nd Century Group, Inc. (XXII Quick QuoteXXII - Free Report) well-placed.

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 companies also offer RRPs, such as e-cigarettes, vaping and heat-not-burn variants. A few of the firms are engaged in making devices and attachments needed in vaping and heat-not-burn products. Most 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 international tobacco firms operate in the country through subsidiaries.

4 Trends Shaping the Future of the Tobacco Industry

Soft Cigarette Volumes: The overall cigarette industry has been bearing the brunt of the inflationary environment, which has affected ATC spending patterns. As the external landscape remains dynamic, economic factors like elevated inflation, higher interest rates, global supply-chain hurdles and ATC dynamics, such as purchasing patterns, the adoption of smoke-free products and disposable income, are likely to have an impact on cigarette volumes. Further, cigarette volumes have been affected by strict government regulations pertaining to sales, marketing and manufacturing. Such regulatory norms are imposed due to health hazards caused by the consumption of nicotine. Some guidelines issued by the FDA include the mandatory use of precautionary labels on cigarette packets and self-critical advertisements. Since cigarette sales account for the majority of revenues for companies in the tobacco industry, dwindling sales volumes in this category are a concern.

Cost Inflation: Cost inflation has been hurting the performance of many industry players. Global inflationary headwinds associated with direct materials, tobacco leaf, energy and wages have been a concern. Increased costs associated with smoke-free product research, development and marketplace activities also pose threats to margins.

Pricing Power: Players in the tobacco industry have been capitalizing on the robust pricing power of tobacco products, which also helps them make up for high taxes and soft cigarette sales volumes. Given that smokers are generally undeterred by price increases due to their addiction, this strategy is expected to remain effective for companies operating in the tobacco sector. The high pricing of cigarettes has been supporting revenues and the operating income of players in the tobacco industry.

Smoke-Free Products Gain Prominence: Growing health awareness and stringent government regulations aimed at reducing cigarette smoking have driven many consumers toward low-risk and reduced-risk products (RRPs). These products are promoted as having a less adverse impact on health due to their scientific composition and way of consumption. An increasing number of consumers are turning to these alternatives as a means to quit smoking traditional cigarettes. Major players in the tobacco industry have been allocating resources to expand their presence in this category, including investing in innovations to make these products more user-friendly and energy-efficient. Companies have been experiencing significant revenue growth in the RRP or smoke-free product space. A notable example is the tobacco giant, Philip Morris, which is actively working toward transitioning into a predominantly smoke-free company by 2025. We anticipate that the strength of these products will continue to yield positive results for industry participants as they undergo business transformations toward RRPs.

Zacks Industry Rank Indicates Dull Prospects

The Zacks Tobacco industry is housed within the broader Zacks Consumer Staples sector. The industry currently carries a Zacks Industry Rank #179, which places it in the bottom 29% 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 drab near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

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

Industry vs. Broader Market

The Zacks Tobacco industry has underperformed the Zacks S&P 500 composite while outperforming the broader Zacks Consumer Staple sector over the past year.

The industry has declined 0.2% over this period compared with the broader sector’s drop of 2.4%. Meanwhile, the S&P 500 has risen 10.6% 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 staple stocks, the industry is currently trading at 9.84X compared with the S&P 500’s 19.19X and the sector’s 17.3X.

Over the past five years, the industry has traded as high as 14.17X, as low as 9.14X and at the median of 11.08X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)


 

4 Tobacco Stocks to Keep a Close Eye On

Philip Morris International: The company has been leveraging its robust pricing capabilities to its advantage. Philip Morris' strategic emphasis on expanding its presence in the RRP sector has also proven successful. This Zacks Rank #3 (Hold) company is on track to achieve its goal of transitioning into a primarily smoke-free entity by 2025. In this regard, the IQOS, a heat-not-burn device, counts among one of the leading RRPs in the industry. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Zacks Consensus Estimate for PM’s 2023 EPS has dropped from $6.23 to $6.21 in the past 30 days. Shares of Philip Morris have climbed 1.2% in the past year.

Price and Consensus: PM

Altria Group: This manufacturer, marketer, and distributor of smokeable and oral tobacco products currently carries a Zacks Rank #3. Altria’s commitment to a smoke-free future is remarkable, as part of which it offers oral tobacco, e-vapor and heated tobacco products. MO’s investment in on!, a popular tobacco-derived nicotine pouch product, has been delivering strong results, in particular. Effective pricing strategies have also contributed to the company’s growth. Altria envisions the full-year 2023 adjusted EPS in the band of $4.89-$5.03, calling for 1-4% growth from the year-ago period figure.

Altria shares have risen 6.3% in the past year. The Zacks Consensus Estimate for MO’s 2023 EPS has risen by a penny to $5.00 over the past 30 days.

Price and Consensus: MO

Turning Point Brands: This manufacturer, marketer and distributor of branded consumer products, such as alternative smoking accessories and consumables, currently carries a Zacks Rank #3. The company is gaining from its wide market presence, including its online operations. Turning Point Brands’ Zig-Zag and Stoker’s product segments have been performing well. On its last earnings call, management raised its guidance for the full-year 2023 based on a robust first-half show.

Turning Point Brands shares have dropped 0.6% in the past year. The Zacks Consensus Estimate for TPB’s 2023 EPS has remained unchanged at $2.50 over the past 30 days.

Price and Consensus: TPB

22nd Century Group: The plant biotechnology firm concentrates on developing technologies that can alter the nicotine content in tobacco plants and the cannabinoid content in hemp/cannabis plants. 22nd Century Group's dedication to its mission of reducing the harm associated with smoking by providing low-nicotine tobacco cigarettes has proven successful. This Zacks Rank #3 company’s cost-reduction program bodes well.

The Zacks Consensus Estimate for 22nd Century Group’s 2022 bottom line has deteriorated to a loss of $4.14 over the past 30 days. Shares of XXII have declined 93.7% in the past year.

Price and Consensus: XXII