Smoking Out the Hot Tobacco Stocks

With interest rates so low, the story of 2011 was the hunt for yield. As a result, a tremendous amount of money flowed into tobacco stocks.

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It was a double win for investors. Domestic names like Altria , Lorillard and Reynolds American all out-performed the broader market, and the smallest yield of the three was 4.5 percent (Lorillard).

But 2012 is a different story — at least with U.S.-based brands. Reynolds American is flat for the year, while Altria's gains are roughly half of what the S&P has gained. Lorillard is the exception, up almost 20 percent.

The analyst community has shifted a bit as well.

"I have a hold on Altria and Lorillard right now," said Chris Growe, an analyst at Stifel Nicolaus. "It implies that there's not so much upside with the stocks."

He is more cautious on the space due to valuation more than any potential headwind with regulation, litigation or taxation.

"I just don't see them as headwinds right now," said Growe, adding that those potential drags seem to be priced into the stock prices. "There's pricing power, and volumes are down less, which means there's revenue and profit growth."

He likes the companies — just not enough to have buy ratings on them.

For companies with exposure outside the United States, 2012 looks a bit brighter. Companies like British American Tobacco and Phillip Morris International are available for U.S.-based investors to trade with ease, and both have footprints in regions where there's actually growth in smoking. In those developing markets, taxes are lower as well, which means stronger profit margins.

According to Goldman Sachs' price target, BTI's stock has a potential 12-month upside of 37 percent. Then, couple that with a 4-percent yield, and the oft-considered defensive stock looks like a monster.

Phillip Morris is much bigger — $150 billion market cap — with a slightly lower yield at 3.5 percent. Most analysts have it as a top pick in the consumer staples space, but not all analysts are totally bullish. UBS recently put out a note and said they only expect an 8-percent gain for 2012, and that's with the dividend.

Despite solid yields and better growth prospects, there are some things to consider with the international tobacco business. The low taxation environment could change, and as countries develop, they'll likely introduce stronger regulation on tobacco products.

Right now, neither has been a material hindrance, but it's something to watch.

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