Is it worth investing in sinful stocks?

Sin stocks are that guilty little investment you may have hidden in your portfolio. You might not boast about this investment, but you have it because you believe it will be lucrative. In some cases, it may have delivered beautifully (think BHP (ASX: BHP) in the past few years). In others, it may have challenged your expectations on returns (such as Pointsbet (ASX: PBH)).

A sin stock is essentially a company that may counter specific societal norms on ethics or morals but an investor chooses it because they believe it will be lucrative. 

Traditional sin stocks cover gambling, alcohol, tobacco and weapons – but a more modern take factoring a range of things such as concerns over the environment for example, would also include oil and mining, big pharma and adult entertainment.

In this mini-series, I’m going to explore these ‘sin’ categories, some of the biggest companies in these spaces and their prospects – to figure out whether they are really that lucrative for your portfolio or if should you be wary. To be clear, I won't be exploring the moral or ethical concerns involved in these stocks but will simply discuss the financials for those who are interested. In this first wire, I’ll look at alcohol and tobacco.

The changing fortunes of alcohol and tobacco

A mere 100 years ago, tobacco held some (albeit loose) health associations – though when concerns started to increase from the 1930s, doctors were even used in advertising to relax a suspicious public.

By contrast, the alcohol industry had been decimated by the US prohibition era. Companies like Anheuser Busch moved into non-alcoholic products like infant formula and carbonated coffee, along with vehicles.

What a difference a century makes.

While alcohol is far from immune to health dangers (cirrhosis of the liver anyone?), the fall of the mighty has been considerable in terms of tobacco. There have been class actions relating to dangerous and addictive ingredients like nicotine, government-funded education programs to discourage smoking and, in many countries, significant regulation around sales and packaging. Meanwhile, alcohol has also veered into consumer staple territory, hitting peaks during the COVID-19 pandemic.

The tobacco industry has been further hit by the popularity of vapes in younger generations, which are equally concerning from a health perspective. 

What this all means for profits…

According to Statista, revenue for the global alcoholic beverages industry amounts to $US1,609 billion. This is expected to grow annually by 5.42% by 2027. 

Projected growth for the Australian industry is relatively in line with figures globally. The top countries in terms of revenue generation are China, the United States, Japan, the United Kingdom and India.

While there is some regulation around alcohol in a range of countries – surrounding how, when and where it can be advertised, along with age and service restrictions, it is a fairly open and growing industry, especially when compared to its prohibition-era past or to tobacco in the present day.

Revenue in the tobacco industry amounts to $US941 billion, according to Statista. It is still expected to grow by 2.5% annually to 2027 – though if we look specifically at Australia, an annual decline of 1.8% is expected to 2027. 

The top countries in terms of revenue generation are China, the United States, Germany, Indonesia and the United Kingdom.

Tobacco is heavily regulated in many countries around the world today. For example, in Australia, you cannot advertise tobacco products and products are required to only have plain unbranded packaging. There are obviously restrictions on age – and smoking is prohibited in a large portion of public spaces.

In countries where there has been increasing regulation and education, there are distinct signs of a decline in sales. For example, a report exploring sales and tobacco use in the USA between 2000 and 2020, found that sales were approximately halved over the period. It also found that current use of tobacco products decreased from 32.2% to 22.9%.

Tobacco companies like Philip Morris International (NYSE: PM) and British American Tobacco (LON: BATS) have sought to invest in alternative products like e-cigarettes and heat-not-burn tobacco. There is also speculation that with regulations changing around the use of cannabis in healthcare, some companies may extend their product lines this way.

If there’s a takeaway for investors, it’s that the alcohol industry is doing very well, but tobacco faces some significant challenges going forward between increasing regulation and declining numbers of smokers. 

There is a large profit margin on tobacco products at current – but can such companies successfully transition their product sets to a ‘smoke-free’ future? And if they are betting on smoke-free in the form of vapes for example, it’s worth considering that regulators are looking closely at this market.

Alcohol and tobacco on the ASX

There is no tobacco manufactured in Australia, nor are there any Australian tobacco companies. Of the international companies operating in Australia, none are listed on the ASX since British American Tobacco delisted from the ASX in 2001.

In terms of alcohol companies, the ASX-listed options follow:

• Treasury Wine Estates (ASX: TWE)
  The global wine company has an international portfolio of wine brands and viticultural assets, including popular and luxury brands like Penfolds, Beringer, Lindemans, Wolf Blass and Rosemount Estate. In the company’s FY23 report, it announced EBIT of $583.5 million, an increase of 11.4%, revenue from ordinary activities of $2,488.3 million, along with basic earnings per share of 35.3 c/share. Market Index’s broker consensus tool positions Treasury Wine Estates as a BUY. Macquarie tipped Treasury Wine Estates as an outperform back in June, arguing that margin improvement has been baked into expectations and suggests it has been oversold off the back of a poor outlook for grape prices.
• Endeavour Group (ASX: EDV)
  Endeavour Group operates Australia’s largest retail drinks network and portfolio of hotels. Dan Murphy’s and BWS feature as part of its extensive portfolio. In the company’s FY23 report, it announced NPAT of $529 million, revenue of $11.88 billion, EBIT of $1.02 billion and total payout of 21.8c/share. Market Index’s broker consensus tool positions Endeavour Group as a Hold, a view Martin Currie’s Jim Power recently concurred with. “They’re a good, dependable company and management team providing a dependable and in-line result,” says Power.
• Lark Distilling (ASX: LRK)
  The whisky distillery and distributor is due to release its annual report for 2023 next week. In the interim, it reported that its organic net sales growth was 15% in FY23 as it expanded into export and travel retail channels, though reported net sales were down on the previous year. Its inventory of whisky under maturation increased to 2.83 million litres and it has received global and domestic recognition for its single malt whisky. Market Index’s broker consensus tool positions Lark as a BUY, while Roger Montgomery of Montgomery Investment Management warns that investors will need to be patient in waiting for inventory to translate to profits (and that’s assuming the quality and reputation of Lark holds up).

The biggest international names

The 3 biggest tobacco companies in the world

It’s worth noting that in a search of Livewire over the past year, none of these tobacco companies were referenced by our fund managers.

• Altria (NYSE: MO)
  The American-based multinational is diversified across tobacco, alcohol and cannabis. It has strategic investments in Anheuser-Busch InBev SA, along with cannabinoid company Cronos Group. In its second half 2023 results, it reported a fall of 0.5% in net revenues to $6,508 million and reported diluted EPS of $1.19. It recently completed an acquisition of NJOY which is a pod-based e-vapor product.
• Philip Morris International (NYSE: PM)
  Philip Morris was previously a subsidiary of Altria but was spun off in 2008. Altria maintains the Philip Morris brands within the USA. Its product portfolio spans cigarettes and smoke-free products, including heated tobacco, e-vapour and oral smokeless products. It is aiming to phase out cigarettes completely. In its second quarter 2023 report, it announced 10.5% growth in net revenues to $9 billion, a 6.9% increase in operating revenue to $2.6 billion and adjusted diluted EPS of $1.60.
• British American Tobacco (LON: BATS)
  The British multinational manufactures and sells cigarettes, tobacco and other nicotine products. It has expanded its portfolio beyond traditional combustible cigarettes to vapour, tobacco heating and oral products. In its second quarter 2023 report, it announced revenue of £13,441 million, an increase of 4.4%, operating margin of 44.2% and net cash generated from operating activities of £3,375 million. Its reported diluted EPS was 176.0p.

The 3 biggest alcohol companies in the world

• Kweichow Moutai (SHA: 600519)
  The Chinese company is the largest beverage company in the world and is responsible for producing Chinese baijiu. It is partially state-owned, and partially publicly traded. For the half year ended June 30 2023, Kweichow Moutai reported a 21% jump in profit and revenue. Its revenue was CNY 70,987.21 million and net income was 35,980.42 million. Earlier this year, abdrn’s Flavia Cheong pointed to Kweichow Moutai as a way of playing the growing Chinese middle-class consumer in coming years.
• Anheuser-Busch Inbev SA (NYSE: BUD) (EBR: ABI)
  The Belgium multinational drink and brewing company is the largest brewer in the world, owning brands such as Budweiser, Michelob, Stella Artois and Beck’s. In its second quarter 2023 earnings report, it noted an increase in revenue of 7.2%, with an EBITDA increase of 5.0%. Its underlying profit was $US1,452 million and normalised EBITDA was $US4,909 million. Lazard's Wayne Robertson referenced it as the only consumer staple stock that looked attractive in March 2023, with a small position in his portfolio.
• Diageo (LON: DGE)
  The British multi-national alcoholic beverage company is a major distributor of scotch whisky and other spirits. It holds a broad suite of brands, such as Smirnoff, Johnnie Walker and Guinness. In its FY23 earnings report, Diageo announced an 11% increase in net sales to £17,113 million, operating profit of £4,632 million and earnings per share of 164.9p.

Do you hold any of these stocks and have they benefitted your portfolio? Let us know in the comments.