Tobacco - smoke without fire

Certain fund managers may have resumed long quashed smoking habits during this tempestuous summer, but even if they did not, the tobacco majors are in rude health, with prices having fallen less far of late. We will look at whether they have received new flows of institutional money given their ability to ride out moments like this.

Low short interest in the majors

This is not a heavily shorted sector, and where a degree of demand exists to borrow the shares, it tends to coincide with either a dividend record date or the existence of convertible bonds. Short interest in the likes of British American Tobacco (LSE:BATS), Philip Morris (NYSE:PM), Japan Tobacco (TYO:2914) and Altria (NYSE:MO) is all below 1.5% of shares.

High short interest due to arbitrage

Universal Corp (NYSE:UVV) processes, stores and ships tobacco leaf, and has a form of convertible bond in issue to explain high short interest at around 16%. In a lovely irony, the second highest short position in the sector is a maker of smokeless light tobacco products for those trying to wean themselves off the habit. The small cap Star Scientific (NASDAQ:CIGX) has long been popular with short sellers and currently has 12% of its shares on loan for this purpose. Such negative sentiment was handed a bonus when the courts recently denied the company the ability to earn royalty from Reynolds American (NYSE:RAI), leaving it with total revenue of only USD 770k in the twelve months to June 30th.

Vector Group (VGR) and Alliance One (AOI) also feature in our list of highly borrowed names (see table), but both have instruments in issue that could mean there are other motives than short selling.. In fact, Vector Group offers two products – tobacco and New York real estate – two rather good ports in this storm!

Institutional Ownership

We have some idea that tobacco firms are not popular companies for the famous hedge funds to own. According to Thomson Reuters there is not a single such firm in the top 100 holdings of the top 30 hedge funds as at the end of June. By contrast, 15% of the tobacco firms in the FTSE World index are in securities lending programs as against 12% for the whole basket of nearly 3000 companies. In terms of the recent change, there hasn’t been much movement in BATS, but both Japan Tobacco and Philip Morris have seen high single digit percentage increases in institutional ownership this past month.

Capital Structure Dashboard

The other way to weigh sentiment towards these cash flow rich companies is to look at their corporate bonds. Taking Philip Morris as an example, we see 12 of their bonds in lending programs but with very little on loan in any of them - as can be seen from our NEW capital structure dashboard (click to view). In fact, most of them pay over 4% annual interest, which is pretty handy in today’s zero interest rate environment. Of the near term bonds, we see a pickup in institutional ownership in the 6.875% 2014 bond – hardly surprising to see the popularity of this stock pick up in August given how useful it was to own safe and high yielding instruments during the market fall off. For more information about the New Capital Structure Dashboard, please click here.

Final Word

Gone are the days when litigation hung over this sector. With stability of income in developed markets and growth in emerging markets, these stocks are subject to positive sentiment across the board according to our data. With P/E ratios in the low teens, and if the sovereign debt crisis does not clear, they could attract yet more buyers given that many hedge funds are not currently invested here.