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Performance drag: why Saracen has stubbed its last tobacco stock
on Sep 24, 2013 at 14:23
We have just sold our one remaining tobacco stock.
Tobacco is a mainstay for many income orientated funds; this sector is highly cash generative and has provided consistent dividend growth from above average starting yields.
A restrictive regulatory environment has protected existing operators from new competition and has allowed for exceptionally high margins as the industry has consolidated into fewer large groups.
We have taken a different view from many of our competitors, preferring to invest in companies with genuine revenue growth profiles rather than exposing our shareholders to the risks inherent in a sector facing long-term secular decline.
Our cautious stance is based on a number of strands:
Decline in developed markets
Volumes in developed markets are in irreversible decline. The industry has been successful in offsetting this trend through increasing prices. The affordability of cigarettes is reaching levels which are prohibitive.
Tougher regulatory environment
The regulatory environment is becoming more hostile. From plain packaging to banning retail displays to horrific visual health warnings, governments have been accelerating efforts to deter smokers from their addiction. Despite the obvious attractions of boosting their revenues from taxing tobacco, authorities are increasingly weighing up the additional costs of healthcare associated with smoking.
Slowdown in emerging markets
Growth from emerging markets will temper. The aspirant middle classes will imitate their western counterparts and recognise the harmful effects of smoking. The social stigma attached to smoking is likely to replicate the experience of developed economies. Smoking is twice as prevalent among the populations of emerging countries which is bound to converge over the coming years. It is only a matter of time before the tobacco industry will no longer be able to rely on new markets providing a source of growth.
The new technology of e-cigarettes is heralding a serious threat to the status quo. The development of a product with the potential to satisfy the addictive craving of nicotine without a deleterious health effect is, at best, disruptive to the industry.
It is conceivable for this new technology to open new routes to market as well as new entrants into the smoking segment. In addition, there is evidence to suggest that e-cigarettes will help reduce consumption and represent a first stage of cessation.
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