These Bad Boy Investments are Perfect for This Market

Here’s the thing about sin: though ugly, it tends to roll on in any economy.

This fact is a huge benefit to companies that deal in vice. When searching for investments in a slow-growth or uncertain economy, investors often look to defensive industries such as healthcare, food and utilities. After all, people still get sick and need to eat and stay warm regardless of the state of the economy.

But, it’s seldom mentioned that people consistently do something else in any economy — drink and smoke. In fact, vice just might be the most defensive business of all.

Stocks in the cigarette and beer industries seem to keep on making profits and the stocks keep going up regardless of what the market is doing. While the S&P 500 is lower now than it was 10 years ago, Morningstar’s cigarette industry category soared at a remarkable average of more than +21% a year for the past 10 years. The Beverage-Brewer (beer) category returned an average of about +16% per year for the same period.

And the outperformance is continuing.

Stocks of cigarette companies are up +24% so far this year and the beer stocks are up a lofty +41% on average, compared to less than +4% for the S&P 500.

While the recovery sputters in an environment even the Federal Reserve calls “unusually uncertain”, investors (without a moral objection) might find a profitable port in the storm from the world of vice.

Bad Boys worth a look
Phillip Morris International (NYSE: PM) is the second largest tobacco company in the world (next to China National Tobacco, which has a near monopoly). The cigarette giant owns seven of the world’s 15 leading brands, including the iconic Marlboro brand, Parliament, Lark, Chesterfield and others. Operating in 160 countries, Phillip Morris International has a whopping industry-leading 15.4% market share of the international market outside the United States, and 26% not including China.

Phillip Morris International is the international division spun off by Altria (NYSE: MO) in 2008. The spin off freed the company from a host of legal and regulatory hurdles that face Altria, while capturing the growth in international markets. The company generated 42% of first half 2010 revenue in fast growing emerging markets, and has a huge 30% average market share in the top 10 emerging market countries excluding China.

Although highly defensive, the cigarette industry is not immune to economic conditions as smokers quit or buy cheaper brands in a soft economy. The company estimates worldwide cigarette volume will decrease about -2% in 2010. But, the company estimates its own sales volume to increase about +3% to +4% for the year because of exposure to emerging markets.

Phillip Morris International is an absolute cash cow that generates free cash flow of 30% of net revenue (a figure among the highest for large multinational companies). The company just increased the quarterly dividend +7.4% and the stock now pays a solid 4.6% yield.

Boston Beer Company (NYSE: SAM) is the fourth largest brewer in the United States and the largest domestic producer of craft beer with its flagship Sam Adams brand. Craft beer is differentiated from mass produced beer in that it is defined as any beer that sells less than two million barrels per year. Beer drinkers are increasingly choosing the more unique and rich taste of craft beer.

Craft beer has been the fastest growing category in alcoholic beverages. While liquor and mainstream beer sales fell during the recession, craft beer sales increased +6% in 2008 and +5% in 2009. In the first half of 2010, craft beer sales have increased +9% from last year, compared to a year-over-year decrease for mainstream beer sales of -2.7%.

Boston Beer has plenty of room to grow. While net income more than doubled between 2005 and 2009, the company is still relatively small with 2009 revenue of just $415 million. Boston Beer is well-positioned financially, as it has (as of June 30th) $54 million in cash and no debt.

The stock has soared +80% during the past year and +43% year to date, but it still sells at just under 24 times earnings, which is lower than the beer category average and lower than its average multiple for the past five years.

Action to Take –> Both Phillip Morris International and Boston Beer should continue to generate strong earnings in either a good economy or a bad economy. The resilience of these companies makes them ideal investments in today’s environment. Both stocks can be purchased at current prices.

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