FTSE 350: Vice not so nice

However, while the three vices of alcohol, tobacco and gambling still remained hugely cash generative throughout the recession, it also became clear that they are not altogether immune to economic weakness. Brewer SABMiller saw volumes fall in many of its key markets around the world, as did British American Tobacco, which felt the pinch from cash-strapped smokers trading down to cheaper brands. Even Imperial Tobacco, which sells some of those value fags, couldn't shake off the effects of the downturn entirely - it saw underlying volumes fall 2 per cent in the second half of its financial year.

In the absence of volume growth, companies turned to price increases to keep sales steady. Whether they can keep pushing prices higher in 2010 remains to be seen, particularly as price inflation is starting to moderate for other consumables in many regions. However, all of the large tobacco and beverage groups have outlined huge cost saving programmes which will be implemented over the coming years that should keep profits ticking up even if revenue growth stalls. BAT is looking to take £880m out of its cost base by 2012; SABMiller is looking for $300m a year by 2014.

Whilst the recession has no doubt been partly responsible, the trend towards healthier lifestyles is taking a real toll, and it is probable that 2010 will see no reversal in this year's falls in beer and cigarette consumption. Consumers will also get a helping hand in kicking their bad habits from the introduction of more anti-smoking legislation throughout the year: Spain is extending its workplace smoking ban to include all bars and restaurants, while Bulgaria and Japan are starting to introduce bans covering all public places, while in the UK, MPs recently voted to ban cigarette machines in pubs.

Unsurprisingly, tobacco groups are looking to emerging markets, where legislation is less prohibitive, to make up for weakness in more developed economies. In June, BAT bought Indonesia's fourth largest tobacco company, Bentoel, following a decade of expansion in Asia. It now makes more than a third of its profits in the region, thanks to the aspiration strength of its premium brands there. Imperial Tobacco continued the integration of its 2008 Altadis acquisition, which increased its presence in Africa, Asia and the Middle East, and both groups are likely to seek further targets to tap into emerging market strength.

Emerging markets are key

Alcohol groups, too, will have been thankful of their expansion into new growth markets. SAB's volume weakness would have been much worse had it not been for huge growth in China, where it owns the popular CR Snow beer brand. Diageo has pinned its hopes very much on growth on Asia, to the point where it has been prepared to push through the unpopular move of consolidating factories in Scotland to ensure that it can remain competitive as it expands internationally.

Of course, duty increases are still a risk, as emerging economies wake up to the potential tax opportunities afforded by tobacco and alcohol consumption. Developed governments are also likely to continue upping excise duties as means of regulating consumption of certain drinks, a factor which led to a significant dip in Diageo's sales of ready to drink products in Australia.

Quality pubs worth a tipple

Despite their financial prowess and scope for continuing improvement, tobacco companies have underperformed the wider market this year, as investors shunned their defensive characteristics to tap into the recovery of more cyclical sectors. So, in the topsy turvy 2009, it ended up being pub and restaurant groups that shone, despite the calamitous state of their balance sheets, and no real evidence that pub-going had seen a renaissance. According to British Beer & Pub Association, 52 pubs a week closed throughout the year, while the organisation's analysis of customs data suggests that consumers continue to drink less and less on average each year. Neither trend is likely to abate any time soon, as financial pressures force consumers to rein in their expenditure on nights out.

But rational investment behaviour does now seem to be returning. By the second half of 2009 it started to become apparent that the improvement in trading recovery priced into pub and restaurant shares had proved overly optimistic, and investors started to adopt a more defensive mindset, which is likely to continue into 2010 as the market hobbles along in the face of continuing economic uncertainty.

It's certainly hard to see what the attractions are in some of the more cyclical business that have recovered most strongly this year. The so-called 'toxic' pub companies that had accumulated billions of pounds worth of debt expanding their estates have been forced to make huge write downs on the value of their pubs and dispose of prize assets to aid recovery, which could hinder trading improvement further still. Punch Taverns notably sold pubs to groups including Fuller Smith & Turner, Shepherd Neame and Greene King, and the divide between the leisure haves and have-nots will widen further in 2010.

On the bright side, predominately tenanted pub groups including Punch and Enterprise Inns breathed a sigh of relief when a decision on the beer tie - which forces tenants to buy beer from their landlord - went in their favour. That said, the ruling doesn't make life any easier for the two group's hard-pressed licensees, who will continue to look to pubco's for financial support this year. There have also been rumblings that tenants may now turn to industrial action to challenge alleged overcharging, and with that risk both companies' shares are best avoided - and with the management tussle at Mitchells and Butlers likely to drag on for a while, we'd avoid those shares, too.

Pub groups must also be hoping that noises from government on the sale of cheap alcohol by supermarkets translate into real action. Many campaigners believe the cheapness of supermarket booze encourages problem drinkers, and are proposing a minimum price on alcohol that large grocers would be legally unable to circumvent. Publicans have frequently accused supermarkets of selling alcohol below cost as a loss leader, and hope a new law would encourage more pub drinking. SAB, unsurprisingly, released a statement saying that while it recognised the impact of problem drinking, it didn't support minimum pricing.

That said, certain pubs and restaurants haven't been shy to embrace the value trends themselves. JD Wetherspoon has kicked off 2010 with a January sale offering pints for 99p and meals for £1.99, and analysts believe that the formula should be a winner with cash-strapped consumers this year. Whitbread, meanwhile, will continue the rollout of its gluttonous all-you-can eat Taybarns format, capitalising on the demand for value food that continues to propel Domino's Pizza to even greater heights.

Pubs and restaurants*

*these companies form part of the Travel & Leisure ICB sector

Online gaming ripe for consolidation

Regulation, meanwhile, is also an issue for the gambling industry, particularly for online operators who've spent some of the year continuing to clean up in the aftermath of the US government's prohibition of online gambling. PartyGaming reached a $105m (£66m) settlement with the US department of justice, a move viewed as positive by analysts who felt it cleared away a troubling obstacles in the much needed consolidation of the internet gaming industry. PartyGaming has subsequently announced that it is in informal talks with Bwin, and although the Austrian gaming outfit appeared cool on a possible tie up it's likely that there will be further corporate activity in the coming year.

Ladbrokes, for one, may be looking for a ready-made solution to its own internet shortcomings, which along with an unwieldy debt pile have seen its shares languish this year. However, a £275m rights issue completed in October barely makes a dent in the near-£1bn debt it had accumulated, and with trading in its all important UK shops still deteriorating it's hard to see how Ladbrokes will fund the investment in eGaming it so desperately needs.

William Hill, on the other hand, is back in the running after finally sorting out its own online problems through a joint venture with Aim-traded gaming software provider Playtech. That's crucial because, while the freak sports results that hit the bookies' profits this year are unlikely to be repeated, the shift of gambling onto the internet is inexorable.

And while gambling, like drinking and smoking, has not proved entirely recession proof, internet gaming remains a growth industry in the early stage of its development, currently accounting for just 6 per cent of global gaming expenditure. What's more, few countries have yet to liberalise gambling to the same extent as the UK, but many governments are starting to recognise the taxation opportunity it offers and further regulatory progress is likely this year in places like France. And the holy grail of gambling, the US, still remains a good long-term prospect for online operators, despite historical regulatory issues. Expect pro-gaming senator Barney Frank to make some headway in 2010.

One challenge the industry could do without is the artic weather conditions hitting the UK which has been devastating racing fixtures. Finance directors of the major bookmamers, as well as shareholders, will be hoping the cold snap ends soon before it the profit hit becomes material.

Gambling*