We all know that Don Draper, the chain-smoking, heavy-drinking, philandering star character of the television series Mad Men, can sell anything -- but can he guide you toward good investments?
Over the next few weeks, I'll analyze sectors and companies that Don Draper has created ads for and determine whether they are worthy additions to your portfolio. We'll kick off this series with an industry that's bad for your health but could be good for your wallet.
Thank you for smoking
A domestic tobacco company was Don's key client throughout early seasons, and while smoking may not be as ubiquitous today as it was in the 1960s, there is still a huge cigarette market. According to the most recent statistics from the Centers for Disease Control and Prevention, smokers comprised more than 19% of the total adult U.S. population in 2010. Holy smoke! That's a consumer base of 45.3 million people who are primarily served by three well-established players.
Altria Group (NYSE: MO ) , better known as the parent company of Philip Morris USA, has long been the leader of the pack. This company reported $23.8 billion in revenue for fiscal 2011, and its flagship brand, Marlboro, has been the market leader for more than three decades. Marlboro maintained its dominance in Q1 of 2012 and grabbed 42.3% of the total U.S. retail cigarette market.
Reynolds American (NYSE: RAI ) , which had sales of $8.5 billion in fiscal 2011, is the second largest in terms of revenue and is best known for its Camel and Pall Mall brands. Lorillard (NYSE: LO ) , meanwhile, had sales of $6.5 billion last year and owed more than 88% of this revenue to its top product, Newport.
Thank you for not smoking
Despite billion-dollar sales, results from the first quarter of 2012 indicate that the domestic cigarette industry might be going up in smoke. Altria and Lorillard both experienced sales volume declines of 2.6% and 2.5%, respectively. Reynolds took a much bigger hit and reported a 5.8% drop in volume.
This is not the first time that sales volume has spiraled down, however. Volume for Altria's Philip Morris USA division decreased 4% year over year in 2011, and this was on the back of a 5.3% drop in 2010. In fact, Altria's financial statements reveal that volume has not had positive year-to-year growth since 2000. Reynolds and Lorillard experienced similar drops over the same time period. Some of this decay comes down to legislation, such as the Family Smoking Prevention and Tobacco Control Act, which mitigates the marketing power of domestic tobacco players and prohibits smoking in many public places.
Good for public health, but bad for business.
Where there's no smoke, there's no fire
In response to an eroding cigarette market, Reynolds and Altria have turned to smokeless tobacco products, such as moist snuff, to boost revenue. However, despite a 5% sales volume growth in the total domestic snuff market in 2011, smokeless tobacco does little to compensate for sluggish cigarette sales. For instance, Reynolds' subsidiary American Snuff reported sales of $158 million in 2011. This is only 8% of Reynolds' total sales for that year, and while snuff may offset small quarterly losses, it will never replace cigarettes as the company's core product.
Harvesting your wealth
Despite contracting cigarette sales, heavy government regulation, and a limited market for alternative products, one of the few advantages to investing in the U.S. tobacco sector is the high dividend.
||Annual Dividend Yield
Source: Yahoo! Finance.
Investors who enjoy dividends may blindly jump into these stocks, but such high payout ratios demonstrate that earnings are ceded to shareholders instead of being reinvested for long-term growth.
Now, don't get me wrong: A lot of people in the U.S. smoke, and Altria, Reynolds, and Lorillard will continue to bring in billions of dollars in sales in the coming years. However, just as Don Draper severed ties with his U.S.-based tobacco client, I think we should follow suit with our portfolio. The sales volume of the U.S. cigarette industry is shrinking, and considering the strong growth of the international tobacco market, I find companies such as British American Tobacco and Philip Morris International much more attractive.
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