BTAFF - 4 'Sin Stocks' With Moral Implications

2023-12-09 07:00:00 ET

Summary

• "Sin stocks" are shares in companies involved in activities considered unethical, such as alcohol, tobacco, gambling, adult entertainment, or weapons.
• Certain investors tend to exclude sin stocks, but different cultures have different opinions on what constitutes a sin.
• Investors should always consider the core activities and financial performance of companies before making investment decisions.

When I looked up "sin stocks meaning" on Google, the first hit was from Robeco, which defines them as:

"Shares in companies involved in activities that are considered unethical, such as alcohol, tobacco, gambling, adult entertainment, or weapons. Ethical investors tend to exclude sin stocks, as the companies involved are thought to be making money from exploiting human weaknesses and vices."

That's a pointed definition. But let's also consider their evaluation that (emphasis added):

"Ethical investors tend to exclude sin stocks, as the companies involved are thought to be making money from exploiting human weaknesses and vices. It is a relative concept though, as different cultures have different opinions on what constitutes a sin.

Although sin stocks usually include alcohol, for example, brewing beer or making a fine wine can be considered a noble tradition in various regions or countries in the world.

And whereas some investors exclude weapons manufacturers on moral grounds, serving in the military can be considered an act of patriotism by others."

In short, I understand if the very title of "sin stock" turns you off.

I know, for me, there are certain investments I wouldn't consider morally. But there are others I have no problem with despite their more controversial nature.

Likewise, you have to be the judge about each portfolio pick you make. I'm just asking you to look past the "sin stock" label of the four companies below.

Because while labels are important, they're not always the full story.

The Problem With "Non-Sin" Stocks

For those of you who are interested, there are SRI stocks out there, which stand for socially responsible investing. NerdWallet writes that SRI:

"… is an investing strategy that aims to generate both social change and financial returns for an investor. Socially responsible investments can include companies making a positive sustainable or social impact, such as a solar energy company, and exclude those making a negative impact."

If that sounds literally righteous - an approach that will earn you celestial credit - let's face the facts. Because, just as "sin stock" is somewhat objective, the opposite can be up in the air too.

Consider all the companies a decade and a half ago that suddenly began announcing their concern for the environment. "We care!" they declared, "proving" this by reducing their paper trail.

But were they really doing that because they cared about the environment or because it saved them money?

Some of you might shrug your shoulders at that, and I understand why. After all, if the results are beneficial, why delve too far into the motive. Right?

Maybe. Maybe not. I'll leave that debate for another day. But consider this evaluation from Harvard Business Review :

"Investing in sustainable funds that prioritize ESG (environmental, social, and governance) goals is supposed to help improve the environmental and social sustainability of business practices.

Unfortunately, close analysis suggests that it's not only not making much difference to companies' actual ESG performance, it may actually be directing capital into poor businesses performers."

So not only are you not making any positive impact… you're also not getting rewarded for it, either now or in the afterlife.

I'm not trying to make you a cynical "sin stock" buyer. I just want to encourage you to look beyond labels to the core of what companies do.

It Pays to Know What You're Holding

Stocks are like individuals.

While each has attributes of this category or that one, different management, locations, sizes, and goals make them unique.

That's why their shares perform uniquely.

And while profit alone shouldn't drive your decisions, you need to know what your money will do once you invest it.

In which case, here's more of that Harvard piece:

"How have investors fared? Not that well, it seems. To begin with, ESG funds certainly perform poorly in financial terms. In a recent Journal of Finance paper, University of Chicago researchers analyzed the Morningstar sustainability ratings of more than 20,000 mutual funds representing over $8 trillion of investor savings. Although the highest rated funds in terms of sustainability certainly attracted more capital than the lowest rated funds, none of the high-sustainability funds outperformed any of the lowest-rated funds."

And remember that's on top of far too many having "worse compliance records for both labor and environmental rules" compared to non-ESG businesses.

I think this is important to point out too:

"Why are ESG funds doing so badly? Part of the explanation may simply be that an express focus on ESG is redundant: In competitive labor markets and product markets, corporate managers trying to maximize long-term shareholder value should of their own accord pay attention to employee, customer, community, and environmental interests."

Which reiterates my point. Don't trust anyone else's opinion alone on a prospective portfolio pick - sin stock, SRI/ESG stock, or anything else. Don't trust your first reaction alone either.

Do your research. Think critically. Consider your personal situation, including your moral code.

And then make your decision from there.

VICI Properties Inc. ( VICI ) - Gambling

VICI is an internally managed gaming real estate investment trust ("REIT") that has a specialized focus on experiential properties including casinos, hospitality, and entertainment destinations.

While VICI is mainly known for its iconic trophy properties on the Las Vegas Strip such as Caesars Palace and MGM Grand, the company is a net-lease REIT that structures long-term leases on a triple-net basis.

VICI's portfolio contains approximately 125 million SF of experiential real estate which consists of 54 gaming properties and 38 non-gaming experiential properties.

VICI's core gaming properties feature approximately 60,300 hotel rooms, around 500 retail outlets, and roughly 500 bars, restaurants, nightclubs, and sportsbooks, while their 38 non-gaming properties are bowling entertainment centers that VICI recently acquired from Bowlero ( BOWL ).

In addition to their gaming and non-gaming properties, VICI owns four championship golf courses and has over 30 acres of land adjacent to the Las Vegas Strip that can be used for future development.

As of their latest update, VICI owns a total of 92 experiential assets across 26 states and Canada with a 100% occupancy rate and a portfolio weighted-average lease term of 41.5 years when including all tenant renewal options.

Since 2019 VICI has delivered an average adjusted funds from operations ("AFFO") growth rate of 7.86% and an average dividend growth rate of 8.64%. Analysts expect AFFO per share growth of 11% in 2023, and then AFFO per share growth of 5% and 4% in the years 2024 and 2025 respectively.

VICI has a strong balance sheet and achieved investment-grade credit ratings (BBB-) in 2022.

They have manageable debt with a net leverage ratio of 5.7x, an EBITDA to interest expense ratio of 4.11x, and a long-term debt to capital ratio of 42.02%.

Plus, their debt is 83% unsecured and 99% fixed rate with a weighted average term to maturity of 6.1 years.

Currently, VICI pays a 5.49% dividend yield that is well covered with an AFFO payout ratio of 77.72% and trades at a P/AFFO of 14.18x, compared to their normal AFFO multiple of 16.54x.

We rate VICI a Buy.

Innovative Industrial Properties, Inc. ( IIPR ) - Cannabis

Innovative Industrial is an internally managed REIT that invests in specialized industrial real estate which is used by leading state-licensed operators for the cultivation of cannabis.

The cannabis REIT was formed in 2016 and is the first and only publicly traded company listed on the New York Stock Exchange to provide capital to the cannabis industry through sale-leaseback transactions.

At the end of the third quarter, IIPR's total property portfolio consisted of 108 properties covering roughly 8.9 million rentable square feet ("RSF") across 19 states. Their operating portfolio is comprised of 103 properties, covering 8.1 million RSF that is 98.5% leased on a triple-net basis with a remaining lease term of approximately 14.9 years.

As a percentage of IIPR's annualized base rent ("ABR"), almost 15% is received from properties in Illinois, approximately 14% is received from Pennsylvania, and almost 14% is received from Massachusetts. 90% of their operators are multi-state operators ("MSO") and the vast majority (91%) of their properties are industrial.

Innovative Industrial released its third-quarter earnings results in November and reported total revenue during the third quarter of $77.8 million, compared to total revenue of $70.9 million for the same period in 2022.

Normalized FFO ("NFFO") was reported at $59.1 million, or $2.09 per share in 3Q-23, compared to NFFO of $55.4 million, or $1.97 per share in the third quarter of 2022. AFFO during the quarter came in at $64.8 million, or $2.29 per share, compared to AFFO in 3Q-22 of $60.1 million, or $2.13 per share.

IIPR does not yet have a credit rating from S&P, but they are investment grade rated by Egan-Jones with a BBB+ credit rating.

The company has excellent debt metrics including a debt to total gross asset ratio of only 12%, a long-term debt to capital ratio of 13.42%, and a debt service ratio of 16.2x.

Additionally, IIPR has a very manageable debt maturity profile with no significant debt maturities until 2026.

Since 2020, IPR has had an average AFFO growth rate of 18.96%, however, analysts expect this to normalize in the coming years with AFFO per share projected to increase by 7% in 2023, and then fall by -3% in 2024.

Shares of IIPR pay an 8.50% dividend yield that is well-covered with an AFFO payout ratio of 84.02% and are currently trading at a P/AFFO of 9.44x, compared to its normal AFFO multiple of 27.82x.

We rate Innovative Industrial Properties a Spec Buy.

British American Tobacco p.l.c. ( BTI ) - Tobacco

British American Tobacco is an international tobacco company based out of the United Kingdom that offers a diverse mix of nicotine products.

BTI offers combustible tobacco (cigarettes), vaping products (e-cigarettes), tobacco heating, and modern and traditional oral nicotine products.

BTI sells its combustible products under several well-known brands including Camel, Newport, Dunhill, Lucky Strike, Kent, and Natural American Spirit.

BTI also offers reduced-risk products including e-cigarettes sold under the Vuse brand, tobacco heating products sold under the GLO brand, and modern oral nicotine sold under the Velo brand.

In addition to combustible and reduced-risk products, BTI also sells traditional oral tobacco under the Grizzly brand.

Like other tobacco companies, BTI has recently shifted their focus from traditional combustible tobacco products such as cigarettes, to reduced-risk products such as e-cigarettes and modern oral.

BTI's shift to reduced-risk products has been effective as the company now receives more than 30% of its revenue from non-combustible products in 23 markets and received 16.6% of their total group revenue from non-combustible products in the first half of 2023.

Over the last decade, BTI has had an average adjusted operating earnings growth rate of 3.38% and an average dividend growth rate of 2.86%.

The company has an investment-grade balance sheet with a BBB+ credit rating from S&P Global and sound debt metrics, including an adjusted net debt to adjusted EBITDA of 2.89x (year-end 2022) and a long-term debt to capital ratio of 33.90%.

Analysts expect earnings per share to increase by 5% in 2023 and then increase by 2% and 7% in the years 2024 and 2025, respectively.

BTI pays an 8.82% dividend yield that is secure with an adjusted earnings dividend payout ratio of 57.98% and trades at a P/E of 6.66x, compared to its 10-year average P/E ratio of 13.00x.

Update : Since writing this article, shares in BTU fell over 10% on Wednesday after the company said it would write down the value of some of its intangibles. Jonathan Weber provides a timely update here .

Diageo plc ( DEO ) - Alcohol

Diageo is an alcohol beverage company based out of the United Kingdom that has a portfolio of more than 200 brands. Since its formation over 25 years ago, DEO has been building a portfolio of some of the world's most iconic brands across multiple categories such as vodka, whiskey, rum, beer, and tequila.

Some of their more notable brands include Johnnie Walker (scotch whiskey), Guinness (stout beer), Captain Morgan (rum), Smirnoff (vodka), Baileys (Irish cream liqueur), and Tanqueray (gin).

Since their inception, Diageo has been building leading positions across multiple categories of Spirits and is currently ranked #1 in international Spirit sales.

DEO brands are ranked #1 for total whisky, scotch whisky, vodka, rum, tequila, and gin and their brands are ranked #3 for "other" international whisky.

In addition to its category-leading brands, DEO also has a global distribution network with more than 100 manufacturing sites and sells its beverages in almost 200 countries around the world.

As a percentage of net sales, North America contributes 39%, Europe contributes 21%, Asia-Pacific contributes 19%, Latin America and the Caribbean contribute 11%, while Africa contributes 10% of DEO's global net sales.

Since 2013 DEO has had an average adjusted operating earnings growth rate of 2.44% and an average dividend growth rate of 3.20%.

The company has an investment-grade balance sheet with an A- credit rating from S&P Global and has solid debt metrics including a net debt to EBITDA of 2.73x and a long-term debt to capital ratio of 61.25%.

Diageo fiscal year does not match the calendar year as their fiscal year ends on June 30. For DEO's full fiscal year 2023, they increased earnings per share ("EPS") by 23%, but analysts expect EPS to fall by -8% in 2024 and then increase by 7% in 2025.

DEO pays a 2.78% dividend yield that is well covered with a FY 2023 year-end adjusted earnings dividend payout ratio of 43.51% and the stock is currently trading at a P/E ratio of 17.53x, compared to their 10-year average P/E ratio of 22.41x.

In Closing

Since Seeking Alpha is a stock research site, I will leave it up to you - the individual investor - to decide whether or not any of these stocks meet your standards.

Obviously, you can comment below and express your opinions, which is just as valuable as the content that I write.

Anyway, I'll remind you that whether you own a "sin stock" or not, you should always maintain responsible diversification, which means you should keep everything in moderation.

As always, thank you for reading, and Happy Holidays!

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