Players in the Tobacco industry have been seeing soft cigarette volumes, which have been affected by strict regulatory norms and limitations and rising health consciousness. Also, raw material cost inflation and supply-chain bottlenecks have been concerning. That said, strong pricing power has been an upside.

Moreover, a focus on reduced risk products (RRPs) or smoke-free alternatives has been working well for companies like Philip Morris International Inc. (PM Quick QuotePM - Free Report) , Altria Group, Inc. (MO Quick QuoteMO - Free Report) and Turning Point Brands, Inc. (TPB Quick QuoteTPB - Free Report) .

About the Industry

The Zacks Tobacco industry includes companies that manufacture and sell cigarettes as well as tobacco and nicotine-based products, such as cigars, snuffs and oral tobacco. Some of the companies also offer RRPs, such as e-cigarettes, vaping and heat-not-burn variants. A few of the firms are also engaged in making devices and attachments needed in vaping and heat-not-burn products. Most of the products manufactured by the tobacco industry participants fall under the strict vigilance of the U.S. Food and Drug Administration (“FDA”) and are required to follow the permissible levels of nicotine in manufacturing. Players in this space sell products mostly through large retailers, distributors, convenience stores, drugstores, wholesalers and grocery chains. Additionally, some international tobacco firms operate in the country through subsidiaries.

4 Trends Shaping the Future of the Tobacco Industry

Stern Government Regulations: Cigarette volumes have been bearing the impacts of strict government regulations pertaining to sales, marketing and manufacturing. Such regulatory norms are imposed due to health hazards caused by the consumption of nicotine. Some of the guidelines issued by the FDA include the mandatory use of precautionary labels on cigarette packets and self-critical advertisements. Moreover, campaigns against tobacco consumption have led to increased consumer awareness, which has resulted in lower smoking rates. Such headwinds, along with the rising health consciousness, have been adversely impacting cigarette sales volumes. Since cigarette sales account for the majority of revenues for companies in the tobacco industry, dwindling sales volumes in this category are a concern.

Cost Inflation: An overall inflationary cost scenario has been hurting the performance of many industry players. Companies are witnessing elevated inflation rates due to rising global energy, commodity and food prices due to factors like demand-supply imbalances, labor shortage and the Ukraine war. Apart from these, hurdles in the supply and distribution channels stemming from the pandemic and the Ukraine war have been impacting the availability and cost of certain raw materials. Increased logistic costs remain a concern for many companies operating in the space.

High Pricing a Major Upside: Industry participants have been gaining from the solid pricing power of tobacco products, which also helps them make up for high taxes and sometimes lower cigarette sales volumes. As smokers don’t mind a price hike due to their addiction, this strategy is likely to keep working for players in the tobacco space. The high pricing of cigarettes has been supporting revenues and the operating income of some of the players in the tobacco industry.

Low-Risk Products Gain Prominence: Low-risk tobacco alternatives, also referred to as next-generation tobacco products, have been gaining immense popularity. Compared to cigarettes, these products are claimed to be less detrimental to health due to their scientific composition and manner of use. Consumers are increasingly taking to such products to quit cigarettes. Tobacco biggies have been witnessing substantial revenue growth in the RRP arena. The companies are making investments to expand in this category, such as undertaking innovations to make these products user-friendly and energy-efficient. The performance of tobacco players is expected to continue benefiting from RRPs.

Zacks Industry Rank Indicates Drab Prospects

The Zacks Tobacco industry is housed within the broader Zacks Consumer Staples sector. The industry currently carries a Zacks Industry Rank #217, which places it in the bottom 13% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dim near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since the beginning of July 2022, the industry’s earnings estimate for 2023 has declined almost 2%.

Let’s take a look at the industry’s performance and current valuation.

Industry vs. Broader Market

The Zacks Tobacco industry has outperformed the Zacks S&P 500 composite while underperforming the broader Zacks Consumer Staple sector over the past year.

The industry has declined 10.4% over this period compared with the broader sector’s drop of 3.5%. Meanwhile, the S&P 500 has dipped 13.2% in the said time frame.

One-Year Price Performance

Industry's Current Valuation

On the basis of forward 12-month price-to-earnings (P/E), which is commonly used for valuing consumer staple stocks, the industry is currently trading at 10.16X compared with the S&P 500’s 17.81X and the sector’s 18.31X.

Over the past five years, the industry has traded as high as 15.34X, as low as 9.15X and at the median of 11.24X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)

3 Tobacco Stocks to Keep a Close Eye on

Turning Point Brands: This manufacturer, marketer and distributor of branded consumer products, such as alternative smoking accessories and consumables, currently carries a Zacks Rank #2 (Buy). The company is gaining from its wide market presence, including its online operations. Turning Point Brands’ Zig-Zag and Stoker’s product segments have been performing well, even amid an inflationary scenario, depicting inherent strength.

Turning Point Brands’ shares have dropped 6.3% in the past six months. The Zacks Consensus Estimate for TPB’s 2023 EPS has increased considerably to $2.56 over the past 30 days.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: TPB

Philip Morris International: This Zacks Rank #3 (Hold) company is one of the industry pioneers in driving the shift from cigarettes to RRPs. The company is well-placed toward becoming a majority smoke-free company by 2025. Toward this end, the IQOS, a heat-not-burn device, counts among one of the leading RRPs in the industry. Moreover, Philip Morris has been benefiting from its strong pricing of tobacco products.

Shares of Philip Morris have rallied 11.4% in the past six months. The Zacks Consensus Estimate for PM’s 2023 EPS has remained stable in the past 30 days.

Price and Consensus: PM

Altria Group: This manufacturer, marketer and distributor of smokeable and oral tobacco products currently carries a Zacks Rank #3. The company is benefiting from its strong pricing power. Altria remains optimistic about its journey toward a smoke-free future. To this end, the company’s investment in on! is yielding well. The company expects adjusted EPS growth of 3-6% in 2023.

Altria’s shares have risen 7.8% in the past six months. The Zacks Consensus Estimate for MO’s 2023 EPS has dropped by 2 cents over the past 30 days.

Price and Consensus: MO