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RRPs, Pricing Light Up Tobacco Space Prospects: 3 Stock to Watch

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·7 min read
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Rising demand of low-risk tobacco alternatives has been a significant upside for the Zacks Tobacco industry. Reduced risk products (RRPs), including vaping, e-cigarettes and heat-not-burn variants, are being largely used by smokers due to their less harmful impacts on health. Companies like Philip Morris International Inc. (PM), Altria Group, Inc. (MO), and Turning Point Brands, Inc. (TPB) have been benefiting from the popularity of such products.

However lower cigarette sales have continued to remain a major downside for the industry. Tight regulations and rising health consciousness have contributed toward lowering cigarette smoking rates. Nonetheless, strong pricing power has been offering major respite to a number of companies in the tobacco space.

About the Industry

The Zacks Tobacco industry includes companies that manufacture and sell cigarettes as well as other tobacco and nicotine-based products such as cigars, snuffs, oral tobacco and e-cigarettes. Some firms are also engaged in making vaping and tobacco heating devices. Players in this space sell products mostly through large retailers, distributors, convenience stores, wholesalers and grocery chains.

3 Trends Shaping the Future of Tobacco Industry

Pricing Acts as an Upside: Companies in the space are likely to keep gaining from the pricing power of tobacco products, which also helps them make up for high taxes. As smokers don’t mind a price hike due to their addiction, this strategy is likely to keep working for players in the tobacco space. Evidently, effective pricing strategies have been supporting revenues and operating income for some of the players in the tobacco industry.

Low Risk Products are Gaining Popularity: Low-risk tobacco alternatives, also referred to as next-generation tobacco products, have been gaining immense popularity. As compared to cigarettes, these products are claimed to be less detrimental to health owing to their scientific composition and the manner of use. In fact, consumers are increasingly taking to such products in a bid to quit cigarettes. Markedly, tobacco biggies have been witnessing substantial revenue growth in reduced risk products (RRPs) arena. This has been acting as an upside for several tobacco players. Driven by consumers’ growing enthusiasm toward RRPs and similar smokeless products, tobacco companies are making substantial investments to expand in this category. Companies are engaging in innovations to make these products user friendly and energy efficient. RRPs are expected to continue aiding the performance of tobacco players. However, the U.S. Food and Drug Administration (FDA) is keeping a close tab on the manufacturing and marketing policies of such items to regulate usage among the youth.

Weak Tobacco Sales Volumes: A number of tobacco companies have been eclipsed by dwindling cigarette sales volumes. Strict government regulations owing to health hazards from the use of nicotine have been affecting cigarette sales. Some of the guidelines issued by the FDA include mandatory use of precautionary labels on cigarette packets and self-critical advertisements. Moreover, campaigns against tobacco consumption have led to increased consumer awareness, which has in turn resulted in lower smoking rates. To top these, the COVID-19 pandemic poses the risk of serious lung diseases, which are likely to get exacerbated by smoking. Such factors, along with soft duty-free business owing to reduced travel amid the pandemic have been adversely impacting cigarette sales volumes of some companies. Since cigarette sales account for the majority of revenues, reduced smoking rates are likely to affect the top-line performance of industry players.

Zacks Industry Rank Indicates Solid Prospects

The Zacks Tobacco industry is housed within the broader Zacks Consumer Staples sector. The industry currently carries a Zacks Industry Rank #95, which places it in the top 38% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. Since the beginning of September 2020, the industry’s earnings estimate for 2021 has increased 2.1%.

Given the industry’s encouraging prospects, we present a few stocks one can retain in their portfolio, given their prudent business advancement endeavors. But before that, it’s worth taking a look at the industry’s performance and current valuation.

Industry Vs Broader Market

The Zacks Tobacco industry has lagged the Zacks S&P 500 composite and the broader Zacks Consumer Staples sector over the past year.

The industry has declined 10.4% over this period compared with the broader sector’s decline of 3%. In contrast, the S&P 500 has risen16.1% in the said time frame.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings (P/E), which is commonly used for valuing consumer staples stocks, the industry is currently trading at 10.06X compared with the S&P 500’s 22.03X and the sector’s 18.74X.

Over the past five years, the industry has traded as high as 21.23X, as low as 9.15X and at the median of 13.69X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)

3 Tobacco Stocks to Keep a Close Eye on

Philip Morris International: It is one of the industry pioneers in driving the shift from cigarettes to RRPs. Markedly, the company’s IQOS is one of the leading RRPs globally. Total users of IQOS as of the end of third-quarter 2020 were about 16.4 million. Moreover, this Zacks Rank #3 (Hold) company has long been benefiting from its strong pricing power, which has aided revenues and adjusted operating income even in the face of an unfavorable tax environment and declining cigarette volumes. Notably, the Zacks Consensus Estimate for 2021 earnings has improved 1.4% over the past 30 days. Shares of this well-known tobacco products company have gained 11.2% over the past three months.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: PM

Altria Group: The company has a robust portfolio of cigarettes, RRPs and oral tobacco products. It has also undertaken efforts to expand in the cannabis industry. The marketing and technology sharing agreement between Altria and Philip Morris, pertaining to the sale of IQOS in the United States has been yielding results. Apart from this, the company’s HeatSticks has also been performing well. Moreover, this tobacco biggie, with a Zacks Rank #3, has been on track with the expansion of its oral tobacco products. Notably, the Zacks Consensus Estimate for 2021 earnings has improved 0.8% over the past 30 days. The stock has gained 12.3% in the past three months.

Price and Consensus: MO

Turning Point Brands: This Kentucky-based tobacco company manufactures and markets a wide range of products under three segments namely; Smokeless, Smoking and NewGen Products. The company’s smokeless product category has been gaining from rising same store sales of Stoker’s MST. Its NewGen segment has been witnessing sharp growth on the back of growth in products like Solace and Nu-X. This Zacks Rank #3 company is well positioned to gain from the growth in smokeless products and has been on track with product introductions. Recently, it submitted Premarket Tobacco Applications to the FDA for 250 products in the vapor category. The Zacks Consensus Estimate for 2021 earnings has remained stable over the past 30 days. Impressively, the stock has rallied 27.2% in the past three months.

Price and Consensus: TPB

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Turning Point Brands, Inc. (TPB) : Free Stock Analysis Report

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Altria Group, Inc. (MO) : Free Stock Analysis Report

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