Altria Group Inc (MO), Lorillard Inc. (LO): You Might Want to Avoid This “Can’t Miss Industry”

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There’s a theory among certain investors, that a handful of industries offer “can’t miss” opportunities regardless of the economy. For many years, this theory has held true, and the tobacco industry has led the pack – but new trends suggest otherwise.

Altria Group IncThe Perfect Secular Investment

There is no industry in the world that has dealt with more controversy than the tobacco industry. The industry itself has been the subject of intense political pressure, commercials, laws that restrict smoking in public places, and increased taxes on tobacco.

Let’s just pretend that a report comes out tomorrow that proves the iPhone causes brain cancer. As a result, laws are created against its use in public places, taxes increase drastically on purchases, and information arises that Apple Inc. (NASDAQ:AAPL) knew of this condition and intentionally aimed the product at children. Theoretically, if this were true, do you think Apple Inc. (NASDAQ:AAPL) would survive? My answer is of course not!

Yet, the tobacco industry has dealt with these problems, plus more, for the last 10 years and has taken all criticism in stride. The stocks in this space have greatly outperformed the S&P 500 over the last five years, and have pretty much traded higher on a continuous basis for the last 20 years. To explain, take a look at just how good these stocks have been over the last five years.

Company Ticker 5 Year Stock Return Yield 5-yr Dividend Increase
Altria Group Inc (NYSE:MO) 73% 4.87% 38%
Lorillard Inc. (NYSE:LO) 85% 4.90% 78%
Reynolds American, Inc. (NYSE:RAI) 88% 5.11% 46%
British American Tobacco PLC (ADR) (NYSEMKT:BTI) 50% 3.88% 73%

Why wouldn’t you invest in tobacco? It has been a gold mine! These companies have not only outperformed the S&P 500 four-fold (average), but also pay market-leading yields and continue to give back to shareholders in dividend increases (and also buybacks). In a very volatile market, these stocks have been a safe-haven of sorts, as they have little volatility, high and consistent ownership, and operate in an industry that has endured everything imaginable.

This “Can’t Miss” Rally Might Be Over

While investors have bought tobacco stocks by default as the perfect secular investments – after all, people are going to smoke regardless of the economy – there is one more chart that I find telling. This particular chart is why I am saying that the tobacco run may be over.

Year % Of U.S. Adults Who Are Smokers
2009 21%
2010 21%
2011 20%
2012 18%

According to the U.S. Centers for Disease Control and Prevention, the percentage of American smokers is declining rather rapidly. This in part is due to anti-smoking drugs such as Chantix and nicotine replacement remedies such as Nicorette gum.

After seven years of 20%-21%, the rate of smokers is finally beginning to decline. So what is it that’s creating this decline? Over the years the tobacco industry has endured every possible roadblock and has always done just fine. But apparently, electronic cigarettes are attracting its smokers, and not all of the large tobacco companies were prepared. Already, we are seeing revenue declining year-over-year. While this has occurred in the past, we are yet to see sharp industry declines to correlate with fewer smokers among the general population.

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