A man holds a cigarette.KHAM/Reuters
It's time to pick up smoking again. Relax, I'm talking about tobacco stocks here: They're getting walloped, and that has tended to mark the best time to invest in these dividend-gushing pariahs.
Key North American names such as Lorillard Inc., Reynolds American Inc. and Altria Group Inc. have fallen about 10 per cent since mid-November, far outpacing the decline of the broader market.
Philip Morris International Inc., which sells cigarettes in Asia, Europe and Latin America, has fallen more than 16 per cent.
The downturn has sent dividend yields as high as 5.6 per cent, in the case of Altria. That sort of cash distribution is hard to ignore under just about any scenario – but it's screaming for attention when bonds yield next to nothing and the average yield in the S&P 500 is just 2 per cent.
The backdrop for tobacco stocks isn't encouraging, of course. It rarely is.
The latest dip coincided with an announcement from CVS Caremark Corp. that the U.S. drugstore chain will stop selling cigarettes at its 7,600 stores in October.
"We've come to the conclusion that cigarettes have no place in a setting where health care is being delivered," said chief executive Larry Merlo.
Even President Barack Obama weighed in on the move, saying the decision "will help advance my administration's efforts to reduce tobacco-related deaths, cancer and heart disease, as well as bring down health-care costs."
If an ex-smoker U.S. President isn't enough to instill fear in investors, there are plenty of other reasons to worry about tobacco stocks.
It's not a growth industry: According to the Centers for Disease Control and Prevention, 19 per cent of U.S. adults smoke cigarettes, down more than 30 per cent in 1985; more than 440,000 adults die each year from smoking-related illnesses.
It's not an attractive industry: Tobacco stocks are shunned by anyone who prefers to invest in nice things.
The stocks are sensitive to rising bond yields: As yields on safe government bonds move higher, dividend yields look less attractive.
But the fact that it is so easy to say no to tobacco stocks is what makes them attractive, especially when they sell off.
One day, no one will smoke – and there will be no wars, poverty or loneliness either. In the meantime, tobacco companies have proved to be remarkably adept at wringing sales and profits out of an increasingly difficult market, by raising prices and adapting to new regulations.
According to Euromonitor International, the number of cigarettes sold in the United States has fallen 40 per cent over the past 15 years, but sales have risen 78 per cent over the same period.
Reynolds American per-share earnings rose nearly 60 per cent from 2004 to 2012, and analysts expect them to rise another 70 per cent by the end of next year.
Companies have been very good at distributing those earnings to shareholders. Altria has raised its quarterly dividend by 65 per cent over the past six years; Philip Morris has doubled its dividend since its spinoff from Altria in 2008.
This fountain of cash helps cushion the impact of rising bond yields. As dividends rise each year, either yields or share prices rise with them. And besides, the threat of rising bond yields is now subsiding: After rising above 3 per cent last year, the yield on the 10-year Treasury bond has since fallen below 2.7 per cent.
As for the announcement from CVS, it sounds good but it's hard to see any significant impact on smoking rates, even if other drugstores follow its lead.
Euromonitor International noted that drugstores account for less than 4 per cent of U.S. retail cigarette sales, and presumably consumers can buy their smokes somewhere else if their drugstore of choice quits the habit before they do. The market has the same impression: CVS shares fell 1 per cent on Wednesday.
For sure, tobacco stocks don't suit every palate. But if you choose to buy, now is a pretty good time.