With The EU’s War on Smoking, Here Are Hedge Fund’s Favorite Tobacco Stocks

Big Tobacco lost a major battle in mid-May after a high court in London rebuffed an attempt by tobacco companies to prevent mandatory plain packaging in England. Because of the ruling, major brand cigarettes in England will soon be pretty much indistinguishable from each other besides standard features such as the brand name. The logos and brand colors are now a thing of the past. Investors worry that courts and governments in other countries (particularly in the EU) could follow England’s lead and mandate plain packaging too. Seeing as how the ruling has negatively affected tobacco stocks, let’s analyze how hedge funds are positioned among the major tobacco companies, such as Philip Morris International Inc. (NYSE:PM), Altria Group Inc (NYSE:MO), Reynolds American, Inc. (NYSE:RAI), Vector Group Ltd (NYSE:VGR), and British American Tobacco PLC (ADR) (NYSEMKT:BTI).

Hedge fund sentiment is an important metric for assessing the long-term profitability. At Insider Monkey, we track over 700 hedge funds, whose quarterly 13F filings we analyze and determine their collective sentiment towards several thousand stocks. However, our research has shown that the best strategy is to follow hedge funds into their small-cap picks. This approach can allow monthly returns of nearly 95 basis points above the market, as we determined through extensive backtests covering the period between 1999 and 2012 (see the details here).

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

– Number of Hedge Fund Holders (as of March 31): 14
– Total Value of Hedge Fund Holdings (as of March 31): $614.36 million
– Hedge Fund Holdings as Percent of Float (as of March 31): 0.60%

Of the 766 elite funds that Insider Monkey tracks in its database, 14 of them owned British American Tobacco PLC (ADR) (NYSEMKT:BTI) at the end of the first quarter, including Jim Simons’ Renaissance Technologies and Joel Greenblatt’s Gotham Asset Management. One reason the esteemed hedge fund managers own the stock is because British American pays a dividend of 3.78%, around twice the 10 year Treasury yield. The stock has also been a good performer of late, with shares up 11.15%. Despite the rally, the stock also trades for a decent forward P/E of only 16.5.

#4 Vector Group Ltd (NYSE:VGR)

– Number of Hedge Fund Holders (as of March 31): 15
– Total Value of Hedge Fund Holdings (as of March 31): $238.27 million
– Hedge Fund Holdings as Percent of Float (as of March 31): 8.40%

15 top hedge funds owned Vector Group Ltd (NYSE:VGR) at the end of March, making Vector the fourth most widely held tobacco stock among the elite funds that Insider Monkey tracks. Vector reported solid first quarter earnings, beating both top and bottom line estimates with EPS of $0.16 on revenue of $380.8 million versus estimates of $0.15 per share and $360.9 million. Adjusted EBITDA was $69.6 million for the quarter, up from $51.3 million for the first quarter of 2015. The company’s real estate segment group reported revenues of $159.7 million, up from $132.7 million from three quarters ago. Because the company is more than just tobacco, Vector Group is a little bit more diversified than its peers and has a higher forward P/E of 26.22. The company also pays an attractive 7.63% dividend yield.

#3 Reynolds American, Inc. (NYSE:RAI)

– Number of Hedge Fund Holders (as of March 31): 39
– Total Value of Hedge Fund Holdings (as of March 31): $1.69 billion
– Hedge Fund Holdings as Percent of Float (as of March 31): 2.40%

Reynolds American, Inc. (NYSE:RAI) was in 39 top hedge fund portfolios in the first quarter, making the stock the third most widely held cigarette stock in the elite fund universe. Like other tobacco stocks, Reynolds American shares have performed well, rallying 9% year-to-date. Shareholders have been buying the stock because Reynolds American pays a dividend yield of over 3.3% and trades for a decent forward P/E of 19. The bad news aspect of the British ruling might also be overblown. England only accounts for a small part of total global tobacco demand and it is unclear how much demand in England will be affected by the new laws. It is also unclear whether other countries will follow progressive England’s lead.

#2 Altria Group Inc (NYSE:MO)

– Number of Hedge Fund Holders (as of March 31): 41
– Total Value of Hedge Fund Holdings (as of March 31): $1.76 billion
– Hedge Fund Holdings as Percent of Float (as of March 31): 1.40%

Sin continues to pay as Altria Group Inc (NYSE:MO) shares have rallied 9.6% year-to-date as dividend investors snap up the stock for its 3.5% dividend yield and its notoriously stable demand. Because Altria mainly sells its tobacco inside the United States, the company isn’t as affected by the ruling as other companies with more international exposure. For full year 2016, Altria expects adjusted diluted EPS of $3-$3.05, giving the stock a price-to -2016-earnings ratio of 21. Cliff Asness’ AQR Capital Management owned 3.4 million shares at the end of March.

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

– Number of Hedge Fund Holders (as of March 31): 48
– Total Value of Hedge Fund Holdings (as of March 31): $3.89 billion
– Hedge Fund Holdings as Percent of Float (as of March 31): 2.60%

Despite being much more international than Altria, Philip Morris International Inc. (NYSE:PM) shares have outperformed that of its former parent, with a year-to-date return of 13% versus Altria’s 9.6% return. One reason for the good returns is the company’s dividend yield of 4.15%. Another reason could be the expectation that the strong dollar might weaken, and thereby help Philip Morris’ international earnings. The company gets almost a third of its revenue from Asia, slightly less than a third from the EU, and the rest from Latin America, Canada, Eastern Europe, the Middle East, and Africa.

Disclosure:None