March 2009

SIN STOCKS: playing vice

While casino and alcohol companies normally flourish in recessions, not so this time, according to the USA Mutuals Vice Fund. Angele Spiteri Paris reports on the so-called ‘sin stocks’ that are posting positive growth...

There are some things people are not willing to give up no matter how bad the economy gets. Vice, or ‘sin’, stocks like alcohol and gambling, usually make for good investment themes in recessionary times.

But this time around, gamblers are holding on to their money and fewer people are drowning their sorrows in drink. Smokers, on the other hand, can still be counted on to provide good returns for tobacco companies.

Historically, vice stocks have been expected to perform during a crisis. According to Merrill Lynch the average outperformance of alcohol, tobacco and casino stocks during recessions has been quite impressive.

In an overview of the sector in November 2008 the firm said: “The group returns nearly 11% versus a 1.5% loss for the S&P 500. In addition, ATC (alcohol, tobacco, casino) stocks significantly outperform consumer staples (+3.9%) and health care (+8.8%) as well.”

This crisis has, however, proven to be so deep that even the stocks that depend on people’s addictions have not been immune from pain.

Charles Norton, portfolio manager of the USA Mutuals Vice Fund, tells Funds Europe: “During the current global economic contraction, the macro powers of deleveraging, liquidity and unprecedented policy action were the driving force behind moves across nearly all asset classes and, unfortunately, our target sectors were unable to escape the wrath of these influences.”

The vice fund invests solely in four sectors – aerospace/defence, gaming, tobacco and alcoholic beverages. USA Mutuals says these were chosen for various reasons, including steady demand regardless of economic conditions and potentially high profit margins.

The gaming sector has been particularly hard hit in the aftermath of the crisis. Norton says: “We have always known that gaming has been relatively more sensitive to fluctuations in the business cycle than others. The big surprise of 2008 was the magnitude and speed with which this sector suffered.”

Other sectors the vice fund invests in, however, have seen more favourable fortunes. “Tobacco, beverages and defence did outperform the broader market but were still down in 2008. While not necessarily reflected in the stock price performance, the operating performance of many of the businesses in our universe continues to be strong.”

As at December 2008, the fund generated returns of 5.64% since inception in August 2002. This is 3.94% more than the S&P 500, which returned 1.70% over the same period.

Smoking kills
Those unable to kick the nicotine habit have been doing investors in the vice sector a big favour. Internationally, tobacco has been performing very well in spite of the crisis.

Phillip Morris International, one of the world’s largest tobacco companies generated earnings per share of $3.32 (€2.64) in 2008, up 16.1% from $2.86 in 2007.

Phillip Morris CEO Louis Camilleri says: “Our operating performance in 2008 was exceptionally strong and our results exceeded our constant currency growth targets for both the full year and the fourth quarter.

“The global economic crisis obviously results in uncertainty… nevertheless, we enter 2009 with solid momentum… our commitment to judiciously invest in the growth of our business and deliver superior returns to our shareholders over the long term remains as steadfast as ever.”

As smoking bans are being introduced in a vast majority of European countries, the firm has diversified its portfolio of products to adjust to this new world.

In February, it announced an agreement with Swedish Match AB to establish an exclusive 50:50 joint venture to commercialise Swedish style snus, a form of snuff, and other smoke-free tobacco products worldwide, outside of Scandinavia and the USA.

Questioned on the effects of legislation like smoking bans on the performance of vice stocks, Norton, of USA Mutuals, says: “In a sense, the government is a partner in some of these businesses and has a financial incentive to see that they continue to survive. We believe that the hand of government works to our benefit, as it creates a significant barrier to entry in our target sectors. For example, tobacco and liquor are both highly regulated.”

Sinful familiarity
Interestingly, one may think that the renewed focus on socially responsible investment (SRI) may hurt funds investing in this sector. According to Norton, though, SRI has actually played to the fund’s advantage.

“Due to investor constraints, the sectors we focus on tend to be overlooked and underfollowed, creating more inefficiencies. We seek to exploit those inefficiencies by the research-driven edge that we have developed through our exclusive focus on these sectors,” he says.

Vice stocks are something every person understands. They hinge on the fact that everyone has a weakness and investors recognise that these weaknesses can be converted into investment opportunities.

New indulgences
Curiously, although traditional vices such as gambling and drinking have not fared very well lately, sales of chocolate and condoms have increased, suggesting people may be indulging in different ways.

Church & Dwight, makers of Trojan condoms, posted an increase in sales. Sales of the contraceptive in the US rose 5% in the fourth quarter of 2008, and 6% in January as compared to the same time periods last year.

Cadbury, the British confectionary giant, also saw positive growth with revenues up 7% in 2008. The growth was attributable to all categories of confection with chocolate up 6%, gum up 10% and candy up 6%.

Todd Stitzer, Cadbury’s CEO, says: “Our strong revenue growth and significant improvement in operating margin demonstrate the relative resilience of our focused business model. While we will not be immune from the continued weak economic environment, at this early stage in 2009, we expect to deliver revenue growth around the lower end of our 4-6% goal range and to make good progress toward our goal of mid-teens margins by 2011.”

©2009 Funds Europe