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Stock Strategist Industry Reports

For Some Smoking Dividend Yields, Look to Tobacco

Despite a runup in stock values, tobacco dividends are still attractive.

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The dust has settled on a turbulent 18 months in the tobacco industry, during which material excise tax increases and smoking bans were implemented in several markets across the world. The ability to raise prices is the key to earnings growth in the tobacco industry, and while these measures negatively impacted volumes, we continue to believe that the pricing power of the leading manufacturers remains intact. The market appears to agree, with tobacco stocks rising by an average of more than 20% during the last six months, outperforming the 9% increase in the S&P 500. Although we anticipate little upside to the stocks at current levels, dividend yields on tobacco stocks are running in the midsingle digits. We think dividend investors with the stomach for "fat tail" risk should still find tobacco stocks attractive in today's low-interest-rate environment.

Tobacco is Conducive to Wide Moats
Both the international and domestic tobacco markets are fairly concentrated, with a small number of large players benefiting from significant economies of scale and generating high returns on invested capital. The addictive nature of tobacco products and strong brand loyalty has produced a category characterized by relatively stable market shares but significant barriers to entry for smaller players and new entrants. Scale advantages are difficult to replicate since new entrants would need to build manufacturing and distribution capabilities, and, at least in the United States, would also be required to set cash aside for product liability damages, either by signing up to the Master Settlement Agreement or by setting aside cash in escrow for product liability penalties. These factors, in addition to the strength of incumbent brands, act as deterrents to new entrants.

Philip Gorham does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.