Tobacco stocks, left for dead by investors, catch fire

Believe it or not, the tobacco industry is on a tear.

Growth investors quit tobacco a while back, seeing it as a utility, with reliable cash streams better suited for big pension funds and other institutional investors — at least those not averse to owning sin stocks.

Consumers were aware of tobacco’s harmful health effects, and many thought the companies would slowly wind down.

Except maybe not: The three big US-based tobacco companies — Reynolds, Altria, and Philip Morris — returned 103%, 87%, and 34% to investors over the past two years, compared to a 14% return on the S&P 500.

At a February investor conference, Newport maker Reynolds American — helped by its recent acquisition of rival Lorillard — deemed 2015 the cigarette industry’s best year in terms of volume since 2006.

While global smoking rates have been declining, about 20% of people around the world still smoke --down from 22% in 2005, according to Euromonitor.

In countries such as Russia, Greece and Chile, those numbers climb to about 40% of the population.

Some of the industry’s performance can be chalked up to consolidation. A stream of mergers over the past few decades left just a handful of big tobacco companies.

The giants that remain have the power to raise cigarette prices every year as taxes and other costs go up, with taxes representing 70% of the price of a cigarette.

The field is likely to narrow even further, with additional mergers at home and abroad.

Many tobacco companies already work together on joint ventures and new-product research and development.

There are also macroeconomic effects at work. Five years ago, drivers paid around $4 a gallon for gas, compared with less than $2 a gallon today.

Because half of tobacco sales occur at the gas station, according to Euromonitor, low gas prices tend to boost cigarette sales, leaving consumers extra money to buy more packs or higher-quality cigarettes.

But perhaps the most interesting development is the industry’s greater focus on research and technology, spawning a host of new smoking alternatives, from electronic cigarettes and chewing tobacco to vapour and smoking-cessation products.

Representing just 1% of the $900 billion (€808bn) global tobacco retail market today, there is plenty of room for growth.

Initially, the industry feared some of these new products would draw smokers away from traditional cigarettes. Instead they are having an “add-on effect,” giving consumers more occasions to consume tobacco.

For example, a smoker who prefers conventional cigarettes at home might use e-cigs or vapour products at a friend’s house or a bar, where traditional cigarettes are less accepted or forbidden.

In the past, a smoker might have just abstained in those places.