Sin Stocks, Once Heavenly Performers, Now Are Damned

Art by Marc Rosenthal

The wages of sin for years have been lush—until the virus came along.

Sin stocks, a loose grouping of shares in such things as alcohol and tobacco, have long benefited from strong demand, bountiful profits, and high dividends. Some condemn these equities as immoral, issued by companies that prey upon personal frailties. Others laud their businesses as slightly naughty, but catering to understandable—if not always healthy—human self-indulgence.

The oldest proxy (launched in 2002) for sin stocks is the USA Mutuals Vitium Global Fund, aka the Vice Fund. Over the past 10 years, it has returned an annual 9.5%. Although that falls short of the S&P 500’s 13.7%, the Vice Fund has done respectably. And some of its members have really romped. Tobacco and alcohol, for instance, have until recently outpaced the market.

The current year has not been kind to the Vice Fund, which is down 12%. Meanwhile, the S&P 500 has gained 4.8%.  The mutual fund, whose ticker symbol is VICEX, focuses on casinos, tobacco, and alcohol, as well as defense stocks. None of its components is doing well in 2020.

Sin Stocks Go to Hell in 2020

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Definitions of sin stocks sometimes rope in aerospace and defense, as they manufacture weapons systems that kill people. On the other hand, military arms producers don’t make consumer products, which is what the reprehensible quintet caters to.

In fact, tobacco and booze stocks have been the best performers over the past 100 years in the US and the UK, according to a study by academics Elroy Dimson, Paul Marsh, and Mike Staunton. No secret why: Products that make people feel good—and can be addictive—have a built-in advantage.

Since the turn of the century, in the developed world, a paper from UBS Quantitative Research shows sin stocks performed strongly, only to sputter in recent years. For a variety of reasons, such as: divestment campaigns among institutional portfolios, tobacco due to the rise of vaping, marijuana's inability to get enough states to legalize it. Tobacco ebbed in 2018 and 2019, and liquor dropped in 2018 and recovered last year. That was merely the warm-up. Come virus-ridden 2020, the overall slide creamed almost every one of these. 

Institutional investors tend to stay clear of sin stocks, not wanting to attract criticism from the public or their boards. At one corporate pension fund, an exception to this rule, alcohol and tobacco are in the portfolio. “Demand for them is inelastic” from consumers, said its investment chief, who requested anonymity and is a user of these companies’ products. “I will pay anything for them.”

And that speaks to the long-term durability of these names, and the hope they may be restored to their former position. Interestingly, the California Public Employees’ Retirement System (CalPERS) lost $3.58 billion in investment gains by unloading its tobacco holdings in 2001, according to a Wilshire Associates study.  The decision, made because of cigarettes’ link to lung cancer and other ailments, aroused intense controversy. An effort by some CalPERS board members to re-invest in tobacco was rejected last year.

Ordinarily, sin stocks “have been recession-proof, with huge profit margins, and are good hedges against inflation,” said Dan Ahrens, chief operating officer at AdvisorShares. His firm introduced its own Vice exchange-traded fund in late 2017. After a plunge in March, along with the rest of the market, the Vice ETF now is close to even with where it started the year. This ETF is into tobacco, liquor, and marijuana.

The COVID-19 plague has disrupted the neat arrangements that these controversial companies have long relished. The five industries that Wall Street labels as sin stocks have, with one outlier (firearms), run into trouble, either because the pandemic messed up their commercial environments (alcohol, gambling) or accelerated headwinds they already were facing (cannabis, tobacco). 

A reversal of the virus and an economic recovery could do wonders for these shares, or at least some of them. Should bars, restaurants, and casinos be able to draw crowds again, and marijuana get legalized in more states, their stocks may well revive. Tobacco is iffier, owing to the popularity of vaping. Firearms may not benefit, as these stocks’ rise results from civic unrest, whose vehemence, some say, stems partly from lockdowns and unemployment.

Here is a tour through the ever-contentious landscape of sin stocks.

Alcohol. Stay-at-home orders and bar and restaurant closings have been especially rough on this sector. Shares in British liquor giant Diageo suffered a 19% drop this year, after quadrupling over the past two decades. The maker of storied labels like Johnnie Walker, Smirnoff, and Guinness saw its 12-month net income halved.

Rival Constellation Brands has less of a concentration on hard liquor, which is more expensive than other drinks. Constellation is known for its wines (Robert Mondavi) and beers (Corona), which sport lower price points, a boon in a recession. They have fared better in sales than the hard stuff. Nevertheless, the company swung into the red in its first quarter, ending in May.

Beer-centric Anheuser-Busch InBev (Budweiser, Michelob, Miller), which has endured volume drops for the year’s first two quarters, is starting to see its sales nudge up. But the stock is still down a third for the year. Part of this is a longstanding problem stemming from its prodigious acquisitions binge, which has loaded on debt. The revenue dip hasn’t helped that situation.

Cannabis. Pot stocks surged wildly about five years ago and, starting last year, have fallen off along with optimism that the drug can be made legal nationally anytime soon. Right now, there is a patchwork of states where it is either 1) OK for recreational use, 2) acceptable only for medical reasons, or 3) still prohibited.

As a result, ETFMG Alternative Harvest ETF, the umbrella for publicly traded marijuana stocks, is down 23% this year. Marijuana consumption is up, nearing $4 billion, by BDS Analytics’ measure. Some providers’ stock has done fine, despite booking losses. Industry sales leader Curaleaf Holdings’ stock has jumped 50% this year. Another big player, Canopy Growth, is off 10%, although narrowed losses in its just-reported quarter and revenue expansion have trimmed that share price losses a bit.

The biggest stumbling block for marijuana in the US is that no nationwide market exists. Just 11 states have fully legalized the drug. New Jersey has a legalization question on the ballot this fall. President Donald Trump has said he backs a bill before Congress that would lift the national ban on the substance. Presumptive Democratic presidential nominee Joe Biden is against federal legalization, although he would keep the question at the state level. He is thinking about lifting federal criminal sanctions against pot, making possession a misdemeanor.

Firearms. The sometimes violent protests following the death of George Floyd, at a police officer’s hands, have brought a dramatic boost to gun buying. Revenue and earnings of gun manufacturers have climbed. Stock in Smith & Wesson Brands has rocketed 150% and that of Sturm, Ruger is ahead 89%. Legendary gunmaker Remington, which is privately held, filed for Chapter 11 in July, although that is related more to its excessive debt than its sales.

Almost 3 million more firearms have been sold since March than would have ordinarily been bought during these months, a Brooking Institution study indicated. In 2020’s first half, some 19 million firearms were purchased, representing more than one gun for every 20 Americans. “There have been a lot of gun sales,” said Mark Travis, CEO of Intrepid Capital.

A political element is usually present during firearms sales expansions. That last happened during the Obama Administration, when many were convinced that Washington was going to ban gun sales and maybe even confiscate privately held weapons. This time, the fear is that the police won’t be able to protect citizens from rampaging criminals, although others think such a threat is hype.

Gambling. Gaming had been an energetic growth industry, pre-epidemic. The Van Eck Vectors Gaming ETF, which covers much of the publicly traded casino action (MGM Resorts, Las Vegas Sands, Galaxy Entertainment), is off 16% this year. MGM’s revenue fell by 90% in the June-ending quarter. Earnings turned negative.

In-person gambling is the one sin stock that depends on crowds. The disease is thought to spread more easily in jammed indoor spaces, making casinos a fretful entertainment choice. Las Vegas is cautiously restarting its shuttered casinos, providing safeguards like plastic shields between seats at table games. Whether it will attract enough visitors to restore profitability remains to be seen.

The gambling sector has not entirely crapped out, however. The return of Major League Baseball, the National Basketball Association, and the National Hockey League has been a godsend to DraftKings, the online sport wagering outfit. Its stock has tripled this year. 

Tobacco. This is an industry in decline. In 1965, some two-thirds of adult Americans smoked. Now that figure has slipped to just below 15%. The virus, a respiratory ailment, doesn’t seem to be driving people to smoking as a stress reliever. Just the opposite.

That has taken a toll on their stocks. Altria Group is down 12% this year, British American Tobacco fell 21%, and Philip Morris International is off 8%. While they have investments in vaping and pot, Big Tobacco is eyeing further declines in its core product.

The devotion of those who do smoke has been such that the tobacco companies could keep hiking prices to make up for sales shortfalls. Not so much anymore. British American initially forecast full-year revenue growth of 3% to 5%. Now it has sliced that to 1% to 3%.

That said, the big three tobacco companies remain profitable. Exception: Altria had a loss last year as the result of a write-down of its investment in troubled vaping concern Juul Labs, although the tobacco giant returned to the black this year. And the tobacco firms' dividend yields are alluring. Altria pays 8%, Philip Morris 6%, and British American 8.4%.

St. Augustine had a smart-aleck prayer: “Oh Lord, make me pure. Just not yet.” Sin stocks will never be pure. The question is when and how will they be able to find their way out of the pit.

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