Yesterday, China's new smoking ban came into effect.
Of course, this isn't the country's first such ban. Four years ago, Beijing issued guidelines' banning smoking in hotels, restaurants and railway stations. But they were largely ignored in a country where around half of all men smoke and where the head of the smoking regulator is also the CEO of the state tobacco firm.
Butthis time the government seems a lot more serious. Unlike the previous ban, this one will apply to all indoor spaces, including offices and factories. A large number of inspectors, with the power to fine individuals and businesses, will be deployed to make sure that it is enforced. There will also be measures against tobacco ads.
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China isn't the only emerging market cracking down on the habit. Russia passed a similar ban a year ago, building on a 2013 law. Brazil's ban also came into effect last summer.
This may be good news for the lungs and hearts of the people in those countries, but it is bad news for global tobacco companies. Here's why and the one stock that you should buy instead.
Consumers in developed countries are quitting smoking
As a result, the percentage of smokers has declined rapidly. Surveys suggested that as late as the mid-1970s, four out of ten adults in the US smoked regularly. Now, it's less than one in five. Similar falls took place during the same period in the UK.
Meanwhile, those who continue to smoke tend to buy fewer cigarettes than before. The combination of both trends has led to a dramatic plunge in the number of cigarettes sold down by 42% in the UK in the last 15 years. In the US, volumes have dropped by a third during the same period.
Emerging market sales are flatlining
The Chinese market is dominated by the state-run China Tobacco, which contributes 7% of the Chinese government's revenue. But other markets are far more open.
British-American Tobacco (BAT), the world's second-largest tobacco firm by market capitalisation, now gets over a third of its revenue from Eastern Europe, the Middle East and Africa,and 27% from Asia.
However, even these markets are starting to shrink as governments start to tighten up regulations and raise taxes. BAT has reported zero growth in Asia, and an overall 1.4% fall in sales in its latest annual results.
Tobacco stocks are expensive
Even since 2000, when tobacco firms were dealing with massive lawsuits, these stocks have surged. BAT has risen by nearly ten times in 15 years while Altria has gone up six-fold. Even Philip Morris International has gone up by two-thirds since it was spun out of Altria in 2008.
This performance has earned cigarette companies a reputation of beingrecession-proof. But it also means thatthey are extremely expensive: Imperial Tobacco and BAT trade at 16.3 times and 21.6 times forecast earnings respectively.
This is a huge price for firms in a declining industry. While they offer solid dividends, it's difficult to see how these can be maintained in the long run, if sales keep falling and taxes keep rising.
E-cigarettes are the future
Electronic cigarettes, which deliver a hit of nicotine without the smoke and other chemicals from tobacco, are experiencing a rapid growth in sales. In part this comes from evidence that they are much more effective in helping people quit smoking than other treatments, such as patches. They also benefit from looser restriction on vaping' in public places.
Sales of e-cigarettes are estimated at just under £100m a year in the UK, and as much as $1.7bn in the US. With sales expanding by 25% a year, some experts think that they may overtake sales of traditional cigarettes within a decade.
At the moment, there are a large number of e-cigarette firms. However, this is unlikely to last, with regulators concerned that a wild west' approach has led to a large number of dodgy products.
What's more, in an effort to protect their position and make up for falling sales, the global tobacco giants are also looking to throw their marketing weight between some of the more established products.
All this should present a bigopportunityfor a firm that can produce a medical-quality product.
Why you should buy Consort Medical
The core difference is that it has a licence from the Medicines and Healthcare Products Regulatory Agency (MHRA)in the UK. This not only certifies that it is safe, but allows doctors to prescribe it on the NHS as an anti-smoking device.
Voke is backed by Nicoventures, which is itself owned by BAT,and is being marketing as a safer alternative to smoking. If the product takes off, then Consort (which is in charge of making the device) could stand to make a lot of money.
Since we tipped Consort two years ago, the shares have surged by a third. Despite this, it trades at 16 times forecast earnings for 2017a more than reasonable price given its growth potential.
Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.
He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.
Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.
As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.
Follow Matthew on Twitter: @DrMatthewPartri
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