Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

If sugar is the new smoking, then the makers of fizzy drinks and fattening cakes need to learn some lessons from big tobacco.

Big food companies have achieved pariah status, with sugar taxes already implemented in Mexico and France and a levy planned for the U.K. in two years' time. Last week, sugar producer Associated British Foods accused the government of trying to demonize the product and questioned whether that strategy would help reduce obesity rates.

But it is just that outsider status that has helped lift tobacco companies' performance. Over the past five years, big tobacco has handed investors a 101 percent total return, according to Bloomberg Intelligence's Global Tobacco Product Manufacturing index, well ahead of the MSCI World Index's 42 percent. That is a phenomenal performance for a class of securities shunned by some investors on ethical grounds.

Slapping taxes on cigarettes has hurt the volume of sales. But it also made it easier for tobacco companies to slip through price increases. Food companies need to use emerging sugar taxes to take control of pricing. Big tobacco has traditionally been reluctant to engage in price wars. Not so the food sector, which often gets dragged into supermarket price skirmishes.

And while the initial going will be tough for food companies, the inevitable industry turmoil that will arise from tough regulation will pick off weaker players and make for a stronger group of survivors. That has worked for big tobacco.  

As the chart below shows, China National Tobacco is the world's biggest cigarette maker with a 44 percent share and six international companies control just over a third of the market, according to Bloomberg Intelligence. That's a far more concentrated market than 20 years ago, according to BI analyst Duncan Fox.

Concentrated Market
China has the biggest market share, but six international brands make up the bulk of the rest
Source: Bloomberg Intelligence

Investors also expect further deals. Most recently,  merger and acquisition speculation has surrounded Imperial Brands, with British American Tobacco or Japan Tobacco seen as the most likely bidder. BAT reports first quarter sales on Tuesday.

All this has helped big tobacco groups raise Ebitda margins to 27.7 percent, compared with 19.4 percent for BI's Alcoholic Beverages group. That's paved the way for big dividends -- pretty useful to investors in a low-interest-rate environment. Big tobacco is paying out 63.7 percent of earnings in dividends, just above the MSCI World Index.

Of course, some of the stars have also been aligning for tobacco. The food industry can't count on being that lucky. Global uncertainty has prompted a flight to safety, and while that tends to give a lift to household goods, tobacco is also benefiting. Packaged foods haven't done as well.

Valuation Lights Up
Tobacco companies' multiples have escalated on the industry's better fortunes and safe haven status
Source: Bloomberg Intelligence

Big tobacco companies have also been investing in alternative products such as e-cigarettes, where there could be substantial growth. This market has grown from just $50 million in 2005 to an estimated $7.5 billion in 2015, and could see another 20 percent compound annual growth rate by the end of the decade, according to Euromonitor. Meanwhile, as Gadfly has argued legalizing marijuana in the U.S. creates another potential pot of gold. The analogy for sugar isn't as clear.

And the decline in cigarette volumes is showing signs of stabilizing -- volumes excluding China is estimated to have fallen by about 2 percent in 2015, a much slower deterioration than what was seen over the past few years, according to Euromonitor. The end is also in sight of the 25-year, $200 billion industry settlement arranged with 46 US states in 1998. 

Tailing Off
Global cigarette volumes excluding China are falling less severely than in recent years
Source: Euromonitor
2015 volume is a forecast

Cigarette makers have had years to adjust to a more malign regulatory environment.  For food and drink producers, the pain is only just beginning.

But to better survive the dislocation,  big food should behave less like big supermarkets  -- prone to embark on pernicious price wars at any time -- and more like big tobacco.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net