Tag: dividend

Why do sin stocks outperform?

Reading Time: 3 minutes

Do you know what the best stock of all time is? You may be surprised to hear its a business in a secularly declining industry.

It’s Altria – the tobacco company that owns Philip Morris. Take a look at the returns on that one! Sin stocks outperform!

Altria

Altria isn’t the only sin stock that’s performed well. Sin stocks are stocks of companies that benefit from human vices, such as alcohol, fire arms, gambling, and tobacco. As shown below, I picked a few of these sin stocks and plotted them against the S&P500 over the past 10 years. Those stocks are:

  • Altria – Tobacco
  • RCI – Strip Clubs
  • Anheauser-Busch – Alcohol
  • Diageo – Alcohol
  • Wynn Resorts – Casinos
  • Las Vegas Sands – Casino

SIN Stocks Returns

Note, the chart above is total return so it includes dividends, which I think is important given sin stocks typically have high payouts.

So what gives? I know plenty of people who have invested in the next social benefit (such as solar or water infrastructure) and lost money. One theory of why socially-beneficially stocks under perform is that they try to do good, but do not do it well.

But in my opinion, and what has been discussed elsewhere, the reason why sins stocks outperform comes down to 4 factors:

  • operate in monopolistic or oligopilistic markets
    • Consider cigarette companies which were told they could no longer advertise via new regulation. That essentially eliminated their marketing teams, increasing earnings and cash flow, but also eliminated any new entrants into their space (i.e. if you can’t advertise, you can’t enter)
  • managers may overlook them or underweight them
    • One theory that is that fund managers underweight sin stocks or simply avoid them in order to please their shareholders or their own ethics. In essence, by all the socially responsible funds avoiding these stocks, they make them cheaper at the same time.
  • they also happen to be “bond proxy” stocks
    • As interest rates fell from all time highs in the 70s & 80s to essentially zero following the Great Recession, stocks that are “bond proxies” performed demonstrably well. These sectors include utilities and consumer staples.  Sin stocks (outside of casinos) are also very stable businesses and have nearly inelastic demand. As such, as investors were pushed out of bonds and into stocks, these stable businesses with high dividends were solid opportunities.
  • there may be an embedded risk premium
    • Similar to the “avoiding” bullet above, financial theory would tell us that the because there are lots of funds out there that actively avoid these stocks, that should drive the cost of capital up for sin stocks (and drive it down for non-sin stocks). As a result, investors expect a higher return given the elevated risk premium.

To be clear, I am not advocating that you need to invest in these companies, but I find it fascinating and not something that one would necessarily expect. I also am always trying to understand any biases I may have that prevents me from generating the best returns I can.

Q4 Recap: B&G Foods posts disappointing Q. Time to exit or is it worth sticking around for the 7.2% dividend?

Reading Time: 3 minutesNow that Q4 earnings season is approaching its end and Q1 will begin ramping up before we know it, I wanted to provide a recap of earnings of stocks I’ve favorably mentioned here.

Unlike my last review on TWNK, this company’s Q4 did not go over well. The Green Giant has stumbled and is facing some challenges, and so the market is concerned… Is it time to cut and run?

B&G reported Q4 EBITDA of $69MM, well below consensus estimates of $98MM. Sales were up 15% due to acquisition contributions and the base business sales were down slightly, excluding lost business at Walmart & Sam’s previously disclosed. The main driver of the miss was  declines in maple syrup related to its earlier decision to discontinue private label business, higher marketing spend as well as higher freight costs (many companies are noting this) and negative mix effect. In addition, 2 key retailers delayed shipment causing $4-$7MM of sales to be deferred.

On the other hand, Green Giant frozen (which you may have seen in your grocery store recently with launches such as riced cauliflower, vegetable based tots, and roasted steam-able corn), grew 23% Y/Y making it the second fastest-growing brand in the frozen foods category. That isn’t to say that this specialized market hasn’t had it’s share of competition (e.g. Bird’s Eye). It also saw double digit growth in Pirate’s Brands from distribution winds and mid-single digit growth in Bear Creek sales.

Net/net, a disappointing quarter which helped the bear thesis that the mature brands of B&G will be stagnant to declining over time. On the other hand, the stock is at lows not seen since 2014 and the company has hired a new COO to oversee the company’s growth strategy and implement a new productivity program for the company.

Let’s walk through management’s guidance for 2018 and determine if we should double down or bounce out. 

BGS FCF walk 2018

The center column is the company’s current guidance of $355MM of EBITDA at midpoint and its estimates of capex, interest, taxes for 2018. I’ve done a sensitivity analysis to say, how well are we protected if the company severely misses its own guidance. Note, I did make one assumption here that if the company’s starting to see that it will come in below its guidance, capex will be at the low end of the $50-55MM range it provided and did the opposite if it comes in at the higher end. However, this is a minor assumption in the grand scheme of things.

In the base case of the company hitting its guidance, the stock is trading at a 10% FCF yield, which is well above the 3-5% yields from most companies in the S&P500. We can also see, even in the case where EBITDA is 20% lower than mgmt’s expectations, the $127MM of FCF covers the $125MM of dividend payments currently paid by the company. I’d like there to be more coverage, but we are assuming a pretty meaningful downside here.

In sum, I think its worth sticking around at this point. The downside already seems to be priced in and I think B&G, while it faces some headwinds, should be able to recover as it laps them in 2018. It will be some difficult comps over the next 4Qs, but with a 7.2% dividend yield and 10% FCF yield, I think there is significant cushion here to protect our downside further. If the stock just trades at a 6% FCF yield, it implies a $44 stock price, or 70% upside from today’s levels.

-DD