Five Tobacco Stocks to Buy

Most investors consider cigarette companies as utilities that generate steady cash flow streams over the years. It is true that some small and large investors refrain from investing in “sin” stocks such as tobacco stocks, but there are several strong reasons for investing in this group of equities. Cigarette companies operate in an extremely regulated industry with high barriers of entry, which somewhat protect the revenue streams generated by incumbent companies. Moreover, tobacco companies usually have very loyal customers, who do not give up smoking even during periods of economic hardship. Customers around the world are fully aware of tobacco’s harmful health effects, which makes us believe that global smoking rates will continue to decline in the upcoming decades. According to Euromonitor, approximately 20% of the global population is still smoking, down from 22% in 2005. However, the tobacco industry is not anticipated to decline forever, considering the industry’s strong focus on research and technology. Cigarette companies have been working on developing a wide portfolio of smoking alternatives, such as electronic cigarettes and chewing tobacco, which have already unlocked new revenue streams. The transition to allegedly less harmful smoking products will enable tobacco companies to continue growing in the years ahead. Surprisingly or not, cigarette companies are on a tear, so let’s take a look at five most-favored tobacco stocks in the hedge fund industry.

At Insider Monkey, we track around 730 hedge funds and institutional investors. Through extensive backtests, we have determined that imitating some of the stocks that these investors are collectively bullish on can help retail investors generate double digits of alpha per year. The key is to focus on the small-cap picks of these funds, which are usually less followed by the broader market and allow for larger price inefficiencies (see more details about our small-cap strategy).

#5 British American Tobacco PLC (ADR) (NYSEMKT:BTI)

– Hedge Funds with Long Positions (as of December 31): 15

– Value of Hedge Funds’ Holdings (as of December 31): $451.56 Million

The number of hedge funds from our system with stakes in British American Tobacco PLC (ADR) (NYSEMKT:BTI) remained unchanged in the fourth quarter of 2015 at 15, while the value of those stakes increased to $451.56 million from $398.59 million quarter-on-quarter. The resilience of the tobacco industry, assisted by a sustained volume growth in emerging markets, was reflected in the company’s financial results for 2015. The maker of Lucky Strike and Kent cigarettes experienced a very strong second half of 2015, with cigarette volume increasing by 1.7% year-on-year. Nonetheless, the company’s total Group cigarette volume for the full year was down by 0.5% year-over-year to 663 billion. The decline is notably better than the tobacco industry decline of 2.3%. At constant currency rates, the world’s second largest tobacco company delivered revenue growth of 5.4% year-on-year in 2015, adjusted profit from operations growth of 4.0%, and adjusted diluted earnings per share growth of 10.1%. BAT also sees potential in Next Generation Products such as Vapour Products (e-cigarettes) and Tobacco Heating Products, which will definitely enable the company to keep growing. Shares of BAT are up by 3% in the past 12 months and are trading at 16.5 times expected earnings versus a forward P/E multiple of 21.0 for the Tobacco industry. The company also pays out an annualized dividend of approximately $5.84 per share, which equates to a current dividend yield of 5.12%. Jim Simons’ Renaissance Technologies reported owning 608,700 ADRs of British American Tobacco PLC (ADR) (NYSEMKT:BTI) in its 13F filing for the December quarter.

#4 Vector Group Ltd (NYSE:VGR)

– Hedge Funds with Long Positions (as of December 31): 18

– Value of Hedge Funds’ Holdings (as of December 31): $233.06 Million

There were 18 hedge funds tracked by Insider Monkey with long positions in Vector Group Ltd (NYSE:VGR) at the end of December, as compared to 17 registered at the end of the September quarter. Nonetheless, the total value of funds’ positions shrank to $233.06 million from $233.59 million quarter-over-quarter. Moreover, those 18 funds amassed 8.10% of the company’s outstanding shares on December 31, which represents the highest concentration rate among the five tobacco stocks discussed in this article. Vector Group is a holding company focused on manufacturing and selling cigarettes through the Liggett Group LLC and Vector Tobacco Inc. subsidiaries; selling electronic cigarettes; acquiring and investing in real estate properties or projects through its real estate business. Liggett is the fourth-largest manufacturer of cigarettes in the U.S. based on unit sales. Vector Group generated revenues of $1.66 billion during 2015, up from $1.59 billion reported for 2014. The increase was mainly driven by higher revenues from the real estate business, which more than offset declining revenues generated from the company’s cigarette and e-cigarette businesses. Reportedly, Vector Group’s e-cigarette business represents a possible takeover candidate for large-scale tobacco companies focused on entering the fast-growing “e-cig” industry. The company’s annual dividend payment of $1.60 per share denotes an attractive dividend yield of 7.03%. Shares of Vector Group have advanced 9% during the past 52 weeks. Renaissance Technologies also owns a stake of 6.03 million shares in Vector Group Ltd (NYSE:VGR) as of December 31.

#3 Reynolds American Inc. (NYSE:RAI)

– Hedge Funds with Long Positions (as of December 31): 31

– Value of Hedge Funds’ Holdings (as of December 31): $1.56 Billion

The number of top money managers from our system invested in Reynolds American Inc. (NYSE:RAI) declined to 31 from 33 in the December quarter. Similarly, the value of their equity investments in the company dropped to $1.56 billion from $1.95 billion quarter-on-quarter. Reynolds American is a holding company that owns and operates the following subsidiaries: R. J. Reynolds Tobacco Company, the second-largest tobacco company in the U.S.; Santa Fe Natural Tobacco Company, the second-largest smokeless tobacco products manufacturer in the country; American Snuff Company LLC; R. J. Reynolds Vapor Company, a producer of digital vapor cigarettes; and other entities. The company’s e-cigarette product, VUSE, is the top-selling vapor product in convenience/gas stores, controlling approximately 24% of the entire U.S. market last year. Reynolds American’s net sales for 2015 were $10.68 billion, increasing from $8.47 billion in 2014 due to strong growth in all business segments. The company’s RJR Tobacco segment, which accounted for roughly 81% of net sales in 2015, reached a growth rate of 27.6% last year due to higher volume, favorable product mix, and higher net pricing. Shares of Reynolds American are up by 40% in the past year and trade at a rather rich forward P/E ratio of 19.2. David Winters’ Wintergreen Advisors had 2.48 million shares of Reynolds American Inc. (NYSE:RAI) in its portfolio at the end of 2015.

#2 Philip Morris International Inc. (NYSE:PM)

– Hedge Funds with Long Positions (as of December 31): 35

– Value of Hedge Funds’ Holdings (as of December 31): $3.03 Billion

The smart money sentiment towards Philip Morris International Inc. (NYSE:PM) declined significantly during the October-to-December period, with the number of funds invested in the company dropping to 35 from 42 quarter-over-quarter. What’s more, the value of those funds’ positions declined to $3.03 billion from $3.13 billion quarter-on-quarter. The company’s subsidiaries and affiliates are manufacturing and selling cigarettes, tobacco products and other nicotine-related products in markets outside the United States. Philip Morris’ total cigarette shipments declined 1.0% in 2015 to 847.3 billion units, a rate that is notably lower than the international cigarette market shipments decline of 2.6%. According to fresh estimates, Philip Morris had a market share in the international cigarette market (excluding the U.S) of approximately 15.6% in 2015, up from 15.5% in 2014. Excluding the Chinese market, PM’s share accounted for 28.7% in 2015, which increased from 28.5% in 2014 and 28.3% in 2013. The maker of Marlboro cigarettes (the best-selling international cigarettes) pays out an annual dividend of $4.08 per share, which corresponds to a current dividend yield of $4.14%. Philip Morris International’s shares have enjoyed a great run in the past year or so, advancing 24% in the past 12 months. Andy Brown’s Cedar Rock Capital is the largest equity holder of Philip Morris International Inc. (NYSE:PM) within our database, holding 12.27 million shares as of the end of December.

#1 Altria Group Inc. (NYSE:MO)

– Hedge Funds with Long Positions (as of December 31): 42

– Value of Hedge Funds’ Holdings (as of December 31): $1.65 Billion

Altria Group Inc. (NYSE:MO) is the most popular tobacco stock among the hedge funds followed by Insider Monkey, with 42 funds holding shares of the company at the end of the December quarter. This compares with a number of 41 registered at the end of the prior quarter. The value of hedge funds’ positions in the company grew to $1.65 billion from $1.63 billion quarter-on-quarter. Altria Group is a holding company whose wholly-owned subsidiaries include Philip Morris USA Inc.; John Middleton Co., which manufactures and markets machine-made large cigars and pipe tobacco; UST LLC, which manufactures and markets smokeless tobacco products and wine through its wholly-owned subsidiaries; and others. Altria Group’s 2015 net revenues, which also include excise taxes billed to customers, increased $912 million or 3.7% year-on-year to $25.43 billion, mainly due to higher net revenues in the smokable products segment. It should be noted that the company forecasts 2016 full-year adjusted diluted EPS growth rate in the range of 7%-to-9%. The stock is priced around 18.4-times expected earnings, significantly below the forward P/E ratio for the Tobacco industry. Shares of Altria are up by 19% in the past 12 months. Investors should also be aware that the company pays an annual dividend of $2.26 per share, which yields 3.66%. Cliff Asness’ AQR Capital Management owns 3.41 million shares of Altria Group Inc. (NYSE:MO) as of the end of the December quarter.

Disclosure: None