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Are tobacco and supermarket stocks not the “safe harbour” investments they once were?

Most safe harbour stocks have been confined to a select group of market sectors that include tobacco and food retailers, although enthusiasm seems to be waning for these once dependable stocks
Cigarettes in shopping trolley
Are the cigarette and shopping trolleys in trouble?

A safe harbour (or defensive) stock is usually interpreted as an investment that will retain or even increase its value during periods of turbulence in the market.

Traditionally, most safe harbour stocks have been confined to a select group of market sectors that includes tobacco and food retailers.

However, in recent times, enthusiasm seems to be waning for these once dependable stocks.

Last gasp for tobacco?

The last few years have been a bumpy ride for major tobacco stocks, which are often touted as dependable defensive investments due to a consistent demand for their products, thanks to their highly addictive nature.

Recent developments, including the rising uptake of e-cigarettes (or ‘vaping’) among the general population, particularly younger generations, a growing social aversion to traditional smoking and global regulatory crackdowns have forced big tobacco onto the back foot.

For example, shares in FTSE 100 British American Tobacco PLC (LON:BATS) have fallen 24% in the last three years as the industry has struggled to adapt to the changing product landscape.

It has been a similar story for fellow blue-chip tobacco firm Imperial Brands PLC (LON:IMB), which has seen its share price drop 32% in the same period.

By contrast, the number of adults vaping has risen to more than 40mln from about 35mln over the same period, while the World Health Organization estimates the number of smokers globally has fallen to 1.1bn from 1.14bn in 2000.

BATs has seen some success in this new market, reporting a 95% jump in revenue for its vapour and tobacco heating products (THP) in 2018 to £905mln; however, potential regulatory restrictions on menthol cigarettes and a trend toward greater scrutiny of youngsters vaping in the US market could cause more pain for the sector.

Imperial has also seen good uptake of its myblu vape pens, into which it has poured £100mln over the last few months, although these gains could be snuffed out by a hard-line approach from US regulators.

BATs is also facing an additional headache from its Canadian business, which was left on the edge of bankruptcy in March as the result of a court ruling that demanded the tobacco industry pay almost £8bn (C$13.6bn) in damages to thousands of Quebec smokers who successfully argued that cigarette makers failed to warn them of the health risks.

READ: British American Tobacco’s Canadian subsidiary granted creditor protection

The one saving grace tobacco stocks seem to have left for investors is their dividends, which in the case of both BATs and IMPs, has risen every year since 2014, making them a more-than-attractive target for investors that are willing to sit on the shares and receive dividend payments.

According to Ian Forrest, investment research analyst at The Share Centre, these dividend payments are “the main appeal” of tobacco stocks, particularly for BATs.

He adds that given the uncertain regulatory picture in the US, the shares would no longer be more than a ‘hold’ for medium risk investors, which is a highly equivocal recommendation.

Supermarkets uber alles

Food retailing is another sector considered a safe bet; after all, everyone needs groceries.

However, the reality paints a gloomier picture for the so-called ‘big four’ UK supermarkets: J Sainsbury PLC (LON:SBRY), Wm Morrison Supermarkets PLC (LON:MRW), Tesco PLC (LON:TSCO), and Walmart Inc (NYSE:WMT)-owned Asda; their industry has come under pressure in recent years due to challengers from the continent.

Since setting up shop in the UK in 1990 and 1994 respectively, German discounters Aldi and Lidl have been eroding the market share of the dominant supermarkets through their cheaper offerings.

Over the last three years, Aldi’s share of the UK’s grocery stores has risen to over 7.5% from 6% while Lidl has upped its share to over 5.5% from 4.4% in April 2016.

By contrast, the market share of each of the ‘big four’ has declined over the same period.

Inflation is also playing a factor, as in the world of wafer-thin margins, getting price rises through under customers’ noses during a period of low inflation is a “tough ask”, forcing cutbacks in other areas.

The battle to retain market share and ward off the discounters was highlighted in recent months by Sainsbury’s and Asda attempting a multi-billion pound merger to leapfrog Tesco and become the UK’s largest supermarket.

READ: Sainsbury's and Asda suggest selling up to 150 supermarkets to get CMA approval

However, the deal has run into regulatory hurdles with the Competition and Markets Authority (CMA) querying the effect of the merger on competitiveness in the sector, with the two firms promising price cuts of around £1bn each year to try to address the issue.

The income stream from owning supermarket shares has also not been as reliable as one might have thought it would be.

The payouts from Sainsbury’s and Morrisons are both below their 2015 levels and while Tesco meanwhile, is paying more than it did in 2015, it didn’t pay out anything in 2016 or 2017.

Having said that, according to Laith Khalaf, senior analyst at Hargreaves Lansdown, supermarkets shouldn’t be considered “defensive” stocks at all, mostly due to their exposure to consumer spending.

“Traditionally they’re at the defensive end of retail space, but they are still retail so their fortunes are still tied to the consumer and that will wax and wane with the economy.”

He adds that the sector has “made progress” from where it was three years ago through self-help measures like merger activity and launching their own discount chains, such as Tesco’s Jack’s brand, but the risks from inflation, currency movements, and continual expansion of discounters will continue to be threats to the established supermarkets.

“I still see them as economically sensitive stocks,” Khalaf says, highlighting that e-commerce giant Amazon Inc (NASDAQ:AMZN) could also be poised to break into the sector after its purchase of US supermarket chain Whole Foods in 2017.

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