You need to go back to the English Commonwealth under Oliver Cromwell to find a time when so many of our recreational pursuits had been curtailed by the state. Admittedly, Old Ironsides didn’t have the option of sitting in front of a games console with a joystick in his hand, but at least the pubs were open then.
The licenced trade and sports betting have come a cropper since freedom of assembly was banned. Only the tobacco companies have been allowed to pursue their trade unmolested, ironic given the opprobrium usually reserved for them by the new puritans in our midst.
A Kentucky-based subsidiary of British American Tobacco (BATS) is even working on a potential vaccine for Covid-19. Who would have thought that tobacco plant technology would come in handy against a respiratory ailment?
Clinical issues aside, history does show that tobacco stocks provide a relatively safe haven when the economy tanks, although if you hold them over the long haul you will have to endure volatile periods of trading. A high standard deviation relative to the wider market is characteristic of tobacco stocks, although they’re also perceived as good credit risks by the ratings agencies. You can expect a bumpy ride safe in the knowledge that eight of the 10 largest tobacco companies (or their subsidiaries) have credit ratings of BBB or better. (Investment grade issuer credit ratings are those rated above BBB- or Baa).
The tobacco companies had a dreadful time of it in 2018, so the average return earned in excess of the risk-free rate suffered by comparison to the wider market is reflected in the negative Sharpe ratio for MSCI Tobacco over the past three-year period.
The past few years have posed specific challenges for the industry, but relative returns are certainly more favourable over an extended timeframe. More importantly, the index easily outstripped the MSCI World benchmark in the troubled period between 2007-10.
BATS, Imperial Brands (IMB) and Philip Morris International (NYSE: PM) have registered an average share price fall of 10.9 per cent since the start of the year, against a drop of 14.4 per cent for the S&P 500, with the gap expanding since the most recent low point for equities in the final week of March.
And why not? With income in short supply, analysts at Deutsche Bank reckon that tobacco dividends are safer than most in the market. As at the end of March, the MSCI Tobacco index constituents came with an average dividend yield of 7.57 per cent, for which you would have been expected to pay a share price equivalent to 9.64 times forecast earnings – hardly extravagant.
Though we haven’t been banned from taking solace in snout, the state has made life rather more difficult for the licenced trade. It was good of Whitehall to add off-licences to the government’s list of essential retailers, but the enforced closure of around 47,600 pubs and bars has put a sizeable dent in revenues for pubcos, brewers and distillers.
A leading drinks group like Diageo (DGE), with a relatively low beta of 0.66, should outperform during a bear market. But it derives over 50 per cent of its net sales in Europe through on-trade businesses, which will be only partly mitigated by the steep rise in alcohol sales through supermarkets and corner shops. The group has pulled full-year guidance while making good on its interim dividend pay-out, though you imagine that management – along with the industry at large - is praying for another long hot summer.
As for gambling, there were any number of reasons why you would have got long-odds on the sector even prior to the collapse in sports betting, not least of which the threat posed by a prospective review of the 2005 Gambling Act. The government has committed to make gambling fit for the digital age, which could conceivably entail further restrictions on advertising, tightened responsibility regarding affordability (i.e. due diligence on punters) and increased scrutiny by the Gambling Commission.
The bottom line is that although sin stocks have proved resilient in previous economic slowdowns, they never had to contend with government wilfully undermining the leisure economy. For the moment, virtue prevails, but the sinners among us might still find redemption in tobacco stocks.
