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Can Smoking Growth Continue in 2011?

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Will the world's smoking habit be nipped in the cigarette butt?

Citigroup analysts think so. Global smoking rates are declining in a straight line, and these folks have extrapolated that if things keep going the same way, we could see zero smoking rates in some global markets by 2050. For example, in the U.K., smoking rates went from more than 50% in 1960s to 20% in 2010.

But, with the exception of menthol-puffing Lorillard (NYSE: LO  ) , all of the major tobacco stocks outperformed the S&P 500 in 2010. Is Altria (NYSE: MO  ) really one of the best stocks for 2011, or is the entire tobacco industry positioned for failure with new market norms like increased government regulation and growing excise taxes?

Zero smokers? Really?
OK, I like a provocative headline as much as the next girl, so I get how easy it is to tell folks that we could get to a smokeless world within 40 years. But that's just not going to happen. Yes, it is true that smoking rates have declined considerably since 1960, but that decline has pretty much flat-lined in the past five years, stabilizing at 21% for the United States.

In spite of skyrocketing cigarette costs, loyal consumers continue to partake. The question isn't whether people will smoke but rather which companies within the industry are positioned to succeed.

The Fool recently looked closely at Reynolds American (NYSE: RAI  ) , which may not be the perfect stock, but it isn't a complete failure, either. Philip Morris International (NYSE: PM  ) continues to be an interesting play for investors looking for global sales growth without the U.S. litigation risk, while Altria has maintained all-star status with an 11.8% dividend increase last year and gain of more than 20% in value.

Now, the bad news...
Of course, investing in tobacco stocks doesn't come without some risk. With more than 90% of its sales tied up in menthol-based products, Lorillard does have a somewhat bleak outlook as the FDA considers the future of menthol cigarettes. When a company puts all of its eggs in one basket (e.g., Lorillard's Newport brand), then it is setting itself up for trouble no matter what the industry is, so it's tough to say that Lorillard's problems extend to the entire industry.

Then there's Vector Group (NYSE: VGR  ) . The company's stock price was up more than 50% last summer, but it had a recent drop on concerns that its cash situation may not be completely solid. Still, the stock has increased in value by more than 30% over the past year, and the company is delivering an 9.2% yield to shareholders.

A fresh start in 2011?
The new year isn't just a time for us regular folks to make big changes; many of the big tobacco companies have announced coming changes in their executive teams and overall structures. Since tobacco isn't necessarily considered a growth market, strong management is a key to continued success.

To adjust to a changing global market and reduce management levels, British American Tobacco (NYSE: BTI  ) is cutting its number of regions from five to four. Altria has tweaked its executive management structure with an increased focus on regulatory issues, and Reynolds American will have a new CEO in 2011 after successful CEO Susan Ivey steps down. Again, this is all a good sign for investors: Executives know that they have to run a tight ship to stay afloat in this market.

Now what?
FDA regulation of the tobacco industry has brought widespread fear (and hype) into the market, but things really haven't changed much yet. The FDA is particularly focused on warning labels, childhood prevention, and retailer education, and it isn't clear what, if any, effects this will have on lowering the smoking rate in America. As excise tax rates increase and laws continue to vary by state, the smoking rate has remained stable for the past five years, feeding into the theory that smoking is an inelastic habit for some.

The global market does look to continue its competitive nature, with British American recently looking into a bid for Colombian tobacco firm Protabaco. Excise taxes in some countries may be reaching their tipping point; Russia, for example, doesn't see much room to increase tobacco taxes. I'm sure these global folks are licking their chops for a chance to reach the Chinese market, with a smoking rate of 60% among men and tobacco companies that haven't raised prices in spite of excise tax increases.

No matter your view on "sin stocks," this industry provides stable yields to investors. Will tobacco stocks outperform the market in 2011? At this stage, other than the menthol debates for Lorillard, there doesn't look to be any major litigation or regulation change that would radically shake the market this year, giving investors the green light for growth in 2011.

Some related Foolishness:

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Colleen Paulson does not hold positions in any of the stocks mentioned in this article. Philip Morris International is a Motley Fool Global Gains pick. The Fool owns shares of Altria and Philip Morris International. For more investing strategies, take a look at the Motley Fool's newsletters via a 30-day free trial. The Fool has a disclosure policy.

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