If you're a smoker, you can choose whether to eat at home or at a restaurant, but that after-meal cigarette is a necessity, not an option.
That imperative helps explain favorable second-quarter earnings results from U.S. tobacco companies such as Altria and Reynolds American -- which stand in stark contrast to increasingly gloomy reports from restaurants, retailers, and packaged food makers of sales slumps and pricing pressure.
For companies such as McDonald's, Coca Cola, and Mondelez, which reported downbeat earnings this week, the mantra seems to be: Consumers are coming under increasing pressure. And as they retreat, we'll do our best to muddle through the weakness, but it's not going to look pretty.
Indeed, I warned earlier this month that the outsize sales gains restaurants enjoyed over the past couple of years are due to end. On Tuesday Stifel analyst Paul Westra called for an all-out restaurant recession, if not a broader economic recession. The same story is playing out for retailers, as well as soda makers, packaged-food producers and other consumer-focused companies that are increasing promotions and lowering prices to attract penny-pinching customers.
Tobacco companies, in contrast, have been able to keep raising prices, even as people spend less on shopping and dining out. U.S. tobacco prices rose 3.5 percent in June from a year earlier, compared to a 1 percent rise across all consumer spending categories, according to the U.S. Bureau of Labor Statistics. Tobacco companies were able to raise prices through the 2001 and 2007 recessions, too, even as prices fell in other sectors, such as restaurants and grocery stores.
This pricing power helps tobacco companies ease the pain of rising government taxes and declining smoking rates in developed countries, which have led to lower cigarette volumes. It also makes them a safe haven for investors in a consumer slowdown.
Tobacco stocks tend to outperform restaurants and other consumer-focused companies, as well as the overall market, when the economy starts to sour.
In the six months prior to the December 2007 recession, tobacco stocks in the S&P 500 rose by 7.8 percent, compared to a 4 percent rise in restaurants and a 4 percent drop in the S&P 500. In the six months prior to the March 2001 recession, a similar trend played out: Tobacco stocks rose by 65 percent, while restaurants rose 7 percent and the S&P 500 dropped by 19 percent. Tobacco stocks rose 8 percent, compared to a 4 percent rise in restaurants and 1 percent increase in the broader market, in the six months before the July 1990 recession.
It's true the U.S. tobacco industry has been on a tear in recent years. Altria and Reynolds returned 112 percent and 123 percent to investors in the past three years, compared to a 36 percent return for the S&P 500. That has raised fears the rally will eventually flame out. After all, Altria and Reynolds are trading around 20 times forward earnings, a premium to their five-year average of around 16 times forward earnings.
But sales slowdowns at retailers and restaurants could keep sending investors looking for consumer exposure into tobacco stocks, regardless of valuation.
Plus, with bond yields so low, tobacco companies' hefty dividends will continue to attract yield-seeking investors, who are increasingly parking their money in dividend-paying consumer staples stocks. Like smoking, that kind of regular payout is hard to quit.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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