Vice is nice - and what's more, it's profitable

published 1 June 2006

Consumers don't give up on their bad habits in difficult times. Our view is that, rather than being driven to the bottle by market turmoil, investors would do better to look at investing in it. Vice' stocks gambling, tobacco, alcohol and defence are just about as immune as you can get to growth swings and with the world in a precarious state, defence is not about to go out of fashion either.

MoneyWeek has been advocating opting for vice for a while now; if you had listened to us, you would have been well rewarded. In the past year, FTSE All Share defence stocks rose 58%, mining 100%, oil 72%, tobacco 27% and beverages 22%. And in falling markets, they're even better investments. When the S&P 500 fell 20% between June 2001 and June 2002, tobacco stocks actually rose 7%, says Tracey Cook in Money Management. Gambling stocks gained 20% over the same period. "Throw in a climate of global conflict and a bull market in commodities" and ethical investments look unappealing.

So where should investors be looking now? Although a ban on smoking is imminent, that hasn't stopped tobacco shares outperforming the broader market by 400% since the dotcom crash in 2000 on a mixture of good growth, low valuations and good yields. And the future promises more of the same, according to ABN Amro, with "declining" earnings in

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Western Europe more than offset by increases in emerging nations, both in Europe and further afield. China in particular is the Holy Grail for tobacco firms. The Chinese smoke a third of the world's cigarettes, but only 3% are foreign brands. If this market were to be opened up, foreign firms would, at a stroke, see their market increase by up to 50%.

Security has been a high priority in the UK and the US in recent years, and the shares of defence stocks have been stellar. The FTSE All-Share Aero/Defence sector is up 184% over the last three years and BAE Systems' share price is up 70% over twelve months. The need to fund military requirements means the UK's defence spending is expected to grow by 12% to £35.1bn between 2005 and 2009.

The rise in women drinkers is partly responsible for the 5% increase in UK alcohol sales in the past five years, according to Money Management. The Government is cracking down on the negative effects of over-indulgence, but the extension of licensing hours gives greater cause for optimism.

Finally, gambling. The sector is growing dramatically and, helped by online gambling and gaming, saw revenues of £5.25bn in 2004, with Dresdner Kleinwort Wasserstein expecting double that by 2008, says Marketing Week. Again, on both sides of the Atlantic the regulatory environment is stiffening, but offshore firms such as Sportingbet and 888 should escape the worst of any clampdowns and continue to see earnings growth of the order of the 50% that they saw in 2005, while Britain's own super-casinos will boost the sector's earnings in years to come.

So the picture is clear. It pays to be invested in the vice' sectors, especially in falling markets. And with the World Cup nearly upon us, these firms will be rubbing their hands with glee at the bumper summer ahead. Here are some ways to buy in now.

Profitable ways to invest in vice

One way to buy into vice is through a fund. According to Money Management, the fund with the greatest proportion of tobacco stocks is the Invesco Perpetual High Income fund, with 20%. Top in other areas are the New Star UK Alpha fund, with 15% in defence; the Nordea North American Value fund, with 16% in gambling stocks.

C&C (CCR, e6.25), the London-listed Irish drinks group and maker of Magner's cider, will be looking forward to the World Cup. Its strategy is simple, says Lex in the FT. It reduces the alcohol content of cider to that of beer and sells it as a "premium beverage". Cider sales generate more than two-thirds of the firm's profits; its home market of Ireland accounts for 71%. Last year, volumes in Ireland grew 6% three times the market growth rate - and it has a "proven track record" of rapidly taking market share in Northern Ireland, Scotland and London. The firm's relatively small size could also make it a target in a consolidating industry. It trades on a price/earnings ratio of about 20 times and yields around 2.5%.

Investors Chronicle suggests taking a look at British American Tobacco (BAT) bonds, whose results show strong profit growth (17% in the first quarter), particularly in developing markets, and it has stable cash flow, "well-suited to bond investors". BAT bonds which mature on 9 December 2013 pay a coupon of 5.75% with a 5.6% current redemption yield; the stock yields less, at 4%. The bonds are rated BBB+ by Standard & Poor's.