The Vice Market Is Shifting

Earlier this month, I headed from Virginia to Florida on the Amtrak auto train. I highly recommend this option instead of driving down I-95.

On my way back to the DC area, the sleeper cabins and vehicle spots were all fully booked. So, I had to make the multi-day scenic drive between the I-85 and I-95 corrridors.

I planned my stops around hitting a few museums before my SERM (Southeastern Reciprocal Museums) membership expired. Along the way was the Reynolda House Museum of American Art in Winston-Salem. The estate was the pet project of Katharine Reynolds—wife of tobacco revolutionary R.J. Reynolds.

She created the name “Reynolda” using the feminine Latin-style ending of the Reynolds surname.

I had not made the connection until I was in the gallery behind the gift shop reading the history. And as my travels usually do, it reminded me to take a moment and check in on the big tobacco stocks, including R.J. Reynolds’ parent company: British American Tobacco (BTI). 

Three Smoke-Free “Paths”

As a dividend investor, I’m interested in tobacco trends. Why? Because vices are generally grouped with consumer staples. Technically, you don’t need them. But when the purse strings are getting tightened, they are still one of the last things to get cut. Consumers want their vices in good times… and they definitely still want them in bad times.

One of my personal “vices” is the annual Strategic Investment Conference that just concluded last week. Just as the nicotine market is shifting, so is the global macro order, which was the theme of this year’s gathering. If you missed it, you can still get the transcripts of every speaker and panel—plus, all slides and charts used in the presentations. See the details here. Back to the smoke-free story…

Vapes started to hit the Western markets back in 2007, and their use has really exploded over the past 10 years. When we talk about smoke-free tobacco use, there are three distinct paths: pouches, heated tobacco, and vaping.

Here’s a quick look at the trends in each one.

Just like Google became the verb to describe any web searching activity, Zyn has become the universal shorthand for nicotine pouches. Philip Morris (PM) acquired the brand in 2022 and has aggressively invested in expanding production. It is the dominant player both globally and in the US, but BTI’s Velo brand holds the #2 spot and continues to gain ground.

Of the three smoke-free options, heated tobacco fascinates me most. This device uses real leaf tobacco to create a nicotine-infused aerosol without combustion. The industry leader is IQOS by PM. Its flagship ILUMA is available around the globe. However, only the older models are FDA approved and only available in certain markets. BTI’s glo brand sits in a distant second place.

Vaping is the broadest option of the three and includes disposables, closed-pod systems, and refillables. For the tobacco giants, we’re taking about closed-pod systems where a device uses refills. Disposables are just that, and refillables would be reused with either bought or homemade “vape juice.”

This is the area where PM struggles and BTI really shines. Its Vuse brand is strong in the US, UK, and France. And BTI just launched a new premium device, the Vuse Ultra. JUUL, from JUUL Labs, and Altria’s NJOY have suffered declining usage due to disputes over patent infringement.

A Hold and a Buy

PM is the current leader in smoke-free products. In 2016, management coined the slogan “designing a smoke-free future.” A transition to that future has since become its goal.

By 2019, the company set its sights on earning 30+% of revenue from smokefree. At the time, it was the only big tobacco player passionate about these products. It has since revised that goal to 66%.

I recommended shares back in 2022. I saw this as an income play with a lot of opportunity for share price growth even if they only hit a fraction of their goals. Today, about 40% of PM’s revenues are from smoke-free and shares are up 80% since my recommendation.

PM has carved out its niche with IQOS and Zyn—but the growth story is over. With a current P/E ratio of 26 and a dividend yield of 3.4%, the stock is not an attractive buy. If you own shares continue to hold and collect your income for many years to come.

If you don’t have tobacco exposure, the best buy right now is BTI. It’s closing the gap in pouches and is the leader in closed-pod vapes. Shares currently have a P/E ratio of 14 and a current yield of 5%.

It’s important to note that BTI is an ADR (American Depository Receipt), and one share is equivalent to one share of BAT that trades on the London Stock Exchange. When you look at the dividend history of BTI, it looks like the dividend hasn’t been consistently raised for the past 29 years, but that’s due to fluctuations in currency exchange rates.

You also should know that the depositary bank of these shares, Citibank, charges all shareholders a small custodian fee of $0.02 annually netted against dividends.

At the end of the day, tobacco has always been ruled by a few big players. The smoke-free future will be no different. PM was the clear early leader, but BTI is coming into its own. Both will pay out solid dividends for years to come.

For more income, now and in the future,

Kelly Green