Smoking And Drinking The classic vices never really go out of style. And New Year's resolutions never last. That's why these two tobacco and alcohol stocks should thrive in 2004.
(FORTUNE Magazine) – It's the season for New Year's resolutions. That means that, once again, many of us have pledged to cut the beer out of our daily diet or stop wasting so much money on cigarettes. And just as inevitably, certain stock pickers are betting against our success. That approach might not be sporting, but it is hardly surprising: Greed--unlike boozing or puffing--is one of the seven deadly sins and a renowned motivator of investors.
While the making and breaking of resolutions is an annual ritual, it is one with particular relevance for the coming year. With tech stock valuations having already achieved liftoff, gold on a three-year tear, and uncertainty over what will happen when the Bush administration's economic stimulus programs wear off, investors could use some sure things--like investing in the bad habits other folks aren't likely to shed. That's why FORTUNE set out to find one stock that benefits from smoking and another from drinking, two legal vices whose businesses also tend to throw off a whole lot of cash.
Altria Group (MO, $53), the soothingly renamed consumer-brands behemoth, is something of a twofer, since it pushes cigarettes as well as beer. Altria's most infamous assets are the U.S. and international businesses of Philip Morris, the tobacco company. It also controls 36% of SABMiller, owner of Miller Brewing, which for a century has contributed to society the "Champagne of Beers." Altria also holds an 84% stake in Kraft Foods (KFT, $32), whose only apparent sin--other than that its shares have traded about flat since its IPO in June 2001--is that it peddles Velveeta processed cheese.
What's yummy about Altria is that it's cheap. Sure, the stock is up 90% from its low in early April, when investors feared lawsuits against the U.S. tobacco industry would send Philip Morris USA into bankruptcy. (Altria got relief later that month when an Illinois judge reduced the size of the $12 billion bond he was requiring in order to stay a $10.1 billion verdict against the company while it appeals.) But with shares worth a wispy 11 times Wall Street's estimates of 2004 earnings, a dividend yield of more than 5%, and a valuation anywhere from $10 to $30 below what most analysts believe to be its so-called breakup value, Altria is one inexpensive play on the smoking business.
Breaking up Altria, by the way, isn't mere investment theory. A sum-of-parts analysis is a common way to assess the correct valuation of a conglomerate with many disparate assets, but the theoretical breakup often never happens. Altria, on the contrary, intends to sell off many of its parts just as soon as the industry clears up three remaining major lawsuits, one of which is with the U.S. Department of Justice. The suits aren't trivial, but bullish analysts believe the cigarette firms have adequate reserves to get through them, as momentum has begun to swing in the cigarette companies' favor. An example is the Engle case in Florida, where in May a court reversed a $145 billion judgment against the industry. Analysts who follow the many ups and downs of tobacco litigation think Altria could begin jettisoning its assets within 18 months--and that the parts will be worth considerably more than the whole.
Smith Barney analyst Bonnie Herzog, for example, values Altria at about $60 a share. She's baked into her estimates some fairly rosy assumptions about Philip Morris USA's clearing up its legal problems. "The litigation environment is quite benign, and the calendar of potential suits is quite clear," she says. Looking ahead a few years, David Adelman, an analyst with Morgan Stanley, calculates a post-breakup Altria is worth $81 per share. At recent levels he figures that investors have been giving little or no value to Philip Morris USA's business, a determination that's realistic only if you believe the company will go down in litigation flames. Adelman cites a strong reason for not believing that Philip Morris and its peers will die: Cash-strapped states have come to rely on the $22 billion in annual settlement and excise-tax payments the industry makes. "The states very much need this industry to remain commercially viable," he says.
Altria is also something of a cash cow for investors. Analysts consider its annual dividend of $2.72, which translates to a savings-account-beating 5.1% yield, to be relatively safe and rising, meaning that investors get paid to wait out the litigation. The company is also likely to restart massive stock buybacks next year at an annual rate of more than $3 billion. It's a stock, in short, that could continue smoking for years.
Smoking and drinking go together, of course. And a good way to play the bottle is another multilabel company, Constellation Brands (STZ, $31). A collection of global wine and beer brands, Constellation owns wines as diverse as Almaden Bag-in-the-Box and Manischewitz at the low end, and Australian wine producer Hardy in addition to several Napa Valley wineries at the higher end. Constellation's acquisition of Hardy in 2003, in fact, makes it the world's largest wine company. As a beer distributor, the company handles a number of tasty imports, including Corona Extra, St. Pauli Girl, and Tsingtao.
As with Altria, there's something of a taint on Constellation, namely the suspicion on Wall Street that it grows only by buying other brands--it has bought 12 companies in the past decade. However, its acquired brands are growing nicely, notes Jonathan Feeney, an analyst with Wachovia Securities, who forecasts 2004 earnings growth of 20%, unaided by additional acquisitions. "Constellation is the best booze stock to own," he says, citing its discounted valuation of about 14 times 2003 earnings, compared with an average multiple of 18 for the other alcohol companies he follows. It appears to be even more of a bargain when you factor in the company's booming cash flow.
Wine vendors should also benefit from the trend among fancier Americans--and those who fancy themselves up-and-comers--to drink more wine, especially as the economy rebounds. "There's a lot of good reasons to own wine, compared with beer and spirits, which are staples," says Feeney, who has crunched Bureau of Labor Statistics numbers to show that the upper quintile of income earners drink a disproportionate amount of wine. "Given what's going on with the consumer right now, luxury is where you want to be," he says. Of course, where you might want to be, if Altria and Constellation continue to soar, is in health-care stocks. But that's another story.