The common misconception is that so-called "sin stocks" only perform well when the economy tanks.
But the truth is that purveyors of alcohol and tobacco take their lumps during a recession just like everybody else.
That was certainly true of the world's largest spirits company Diageo PLC (NYSE: DEO), which traded as low as $42 a share in 2008. Of course, the stock has more than doubled since then, closing Friday at $93.38.
Shares of cigarette-maker Philip Morris International Inc. (NYSE: PM) have nearly doubled in the past two years, as well.
Still, you don't have to worry if you missed either of those rallies because there's still plenty of room for these two sin stocks to run.
Indeed, more and more consumers are returning to their vices as the global economy improves.
For instance, liquor sales, which stagnated in 2009, rose 4% last year, while sales of top shelf spirits increased 5.3% — a near return to pre-2008 levels.
What's more is that these gains came at the expense of the beer market, which typically has the upper hand in tough economic times.
"People who are doing well are going out and spending on spirits as an affordable luxury," John McDonnell, chief operating officer for The Patron Spirits Co. and chairman-elect of the Spirits Council, told Bloomberg. "Also, spirits companies never stopped spending through the downturn."
The same goes for tobacco products, which have been gathering steam in emerging markets even while they fall out of fashion in developed countries like the United States.
So let's take a closer look.
Diageo is Uplifting Spirits
Diageo – the company behind Baileys, Captain Morgan, Guinness, Smirnoff, and Johnnie Walker – is the most obvious beneficiary of increased liquor sales.
These are powerful brands that helped Diageo actually increase its cash flow during the recession. And now that consumers worldwide are in a slightly more festive mood, sales are set to take off.
Diageo, which produces about 28% of the spirits sold in the United States, reported a 5% increase in liquor sales in the U.S. and Canada in the second half of 2011.
More importantly, the company continued to expand its business in emerging markets.
While volumes were flat in North America and Europe, Diageo generated 14% volume growth in Latin America, 7% in Africa, and 5% in the Asia-Pacific region.
And that's just the beginning for a company that has made developing markets the focus of its growth strategy.
Diageo increased its marketing spending by 10% to 15.8% of sales in the second half of 2011. And nearly 75% of that increased spending was devoted to emerging markets.
Additionally, the company has taken steps to increase its beer business in the fledgling African market by making some shrewd acquisitions.
In November, Diageo invested $211 million (134 million pounds) for a 20% stake in SABMiller's (PINK: SBMRY) Kenya Breweries. And just last month, the company acquired Meta Abo Brewery in Ethiopia for $228 million (145 million pounds).
Diageo believes Ethiopia's beer market will grow more than 10% annually through 2015. And with its takeover of Meta, the company will command 50% of that market.
This growth potential has clearly been factored into Diageo's share price which is up more than 6% over the past month and 22% in the past year.
The stock is currently trading at roughly 17-times fiscal 2012 earnings and yields nearly 3%.
Phillip Morris Smokes the Competition
Liquor companies like Diageo aren't the only ones toasting success these days, either.
Reynolds, the nation's second-biggest tobacco company, just reported a 16% jump in fourth-quarter profit. And Lorillard, which dominates the market for menthol cigarettes, saw its fourth-quarter profit surge 20%.
Still, tax hikes, smoking bans, health concerns, and social stigma will continue to make life difficult for these companies – especially in the United States.
For that reason Philip Morris International (PMI) may be the best bet for investors.
True to its name PMI has a strong global presence, particularly in Asia. The company said its shipments grew less than 1% to 226.6 billion cigarettes in the fourth quarter, only because a 10.5% in Asia offset declines of about 7% in Europe, Latin America, and Canada.
PMI bolstered its Pacific Rim presence in February 2010 by buying the Philippines' Fortune Tobacco Co. That merger gave PMI 90% of the Filipino market. Meanwhile, the company has broadened its market share in Korea and Indonesia to about 20% and 30% respectively.
In total, PMI holds a 27.6% share of the cigarette market outside of the U.S. and China, with a brand portfolio that includes 15 of the top international brands, including Marlboro.
The company earned $8.59 billion, or $4.85 per share, in 2011 compared with $7.26 billion, or $3.92 per share, in 2010. Revenue excluding excise taxes increased about 14% to $31.1 billion. Its shipments were up nearly 2% to 915.3 billion cigarettes.
Better still, the company's share price has been bolstered by share buybacks and dividend increases.
In fiscal 2011, PMI spent $5.4 billion to repurchase 80.5 million shares of its own common stock. The company plans share repurchases of approximately $6 billion in fiscal 2012.
PMI also has a strong history of dividend increases.
The company hiked its dividend by 20.3% last year to $0.77, representing an annualized rate of $3.08 per common share. There's a good chance the payout will be raised again this year, as well.
So when it comes to sin stocks Philip Morris International and Diageo clearly have an edge over the competition.
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