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RRPs, Price Hikes Likely to Light Up Tobacco Industry's Fate

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The Zacks Tobacco industry consists of companies that manufacture and sell cigarettes as well as other tobacco and nicotine-based products such as cigars, snuffs, oral tobacco and e-cigarettes, to name a few. Some of the firms are also engaged in making vaping and tobacco heating devices. Players in this space sell products, mostly through large retailers, distributors, convenience stores, wholesalers and grocery chains.

Let’s take a look at the industry’s three major themes:

•    Cigarette sales volumes are receding, thanks to strict protocols issued by the Food and Drug Administration. Health hazards arising out of nicotine use have resulted in regulatory whips on tobacco players. Some of the guidelines issued by the FDA include the mandatory use of precautionary labels on cigarette packets and self-critical advertisements. Such stringent regulatory barriers are likely to stub cigarette sales going ahead. Moreover, campaigns against tobacco consumption have led to increased consumers awareness, which has, in turn, resulted in lower smoking rates. Such trends are likely to continue putting pressure on revenues of tobacco industry participants.

•    To cushion themselves from lower demand for cigarettes, as well as high taxes, companies are increasingly resorting to price hikes. As smokers tend to absorb higher prices due to their addiction, this strategy is likely to support players in the tobacco space in the near term.

•    E-cigarettes and other vaping products are gaining immense popularity, courtesy of their low-risk claims. In fact, consumers are increasingly resorting to such products in a bid to quit cigarettes. Driven by the growing enthusiasm, tobacco companies are making substantial investments in the reduced risk products (RRPs) arena. In fact, RRPs are viewed as products that are likely to hold a significant market share and shape up the future of many tobacco firms. However, the FDA is keeping a close tab on the manufacturing and marketing policies of such items to regulate usage among the youth.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Tobacco industry is housed within the broader Zacks Consumer Staples sector. The industry currently carries a Zacks Industry Rank #27, which places it in the top 11% 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 encouraging 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 positioning in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate.

Given the industry’s growth prospects, we present a few stocks one can buy or retain, given their business advancement endeavors. But before that, it’s worth taking a look at the industry’s performance and current valuation.

Industry Lags S&P 500 and Sector

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

The industry has declined 20% over this period compared with the S&P 500’s decline of 2.5%. The broader sector has risen roughly 2.3% 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 10.55X compared with the S&P 500’s 16.48X and the sector’s 19.06X.

Over the past five years, the industry has traded as high as 21.23X and at the median of 17.47X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)

Bottom Line

Continued decline in cigarette sales is a grave concern for tobacco companies. In such a scenario, gradual expansion in RRPs and price hikes are likely to provide some respite. Moreover, companies are undertaking prudent partnerships to augment offerings in low-risk products, and investing in research to advance in this space.  

All said, we are presenting a few stocks from the Zacks Tobacco industry, which are well positioned to capitalize on opportunities.

Vector Group Ltd. (VGR - Free Report) : This Florida-based company currently sports a Zacks Rank #1 (Strong Buy). Some of the renowned cigarette brands of the company are Liggett, Pyramid and Grand Prix. It also offers e-cigarettes. The company has outperformed the Zacks Consensus Estimate by an average of 60% in the trailing four quarters.

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

Price and Consensus: VGR

Philip Morris International Inc. PM: This well-known tobacco player has its operations spread globally. It currently carries a Zacks Rank #3 (Hold). The company’s IQOS is one of the leading RRPs in the industry. Renowned cigarette brands of the company are Marlboro, Parliament and Virginia Slims. Philip Morris has an estimated long-term earnings growth rate of 7.9%. It has outperformed the Zacks Consensus Estimate by average of 10% in the trailing four quarters.

Price and Consensus: PM

Altria Group, Inc. MO: This tobacco biggie, also with a Zacks Rank #3, has an estimated long-term earnings growth rate of 7.7%. The company has a robust portfolio of cigarettes and RRPs. Markedly, it has formed a partnership with JUUL Labs Inc., a leading e-cigarettes maker, known for its advanced and highly-differentiated products.  It has also undertaken efforts to expand in the cannabis industry.

Price and Consensus: MO

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