Vice stocks that can fetch good returns

If you are not troubled by the moral dilemma of investing in liquor, cigarette and gaming stocks, invest in the ones listed below. They have beaten the sensex and done well in economic turmoil

Sanket Dhanorkar 

    Drinking, smoking and gambling are not only considered unhealthy for one's physical and financial health but, more importantly, immoral. So, how about investing in companies, which may not appeal to the collective conscience but are perfectly legal, even profitable? If you are willing to look past this deterrent, investing in the so-called 'vice stocks' can work wonders for your portfolio. So should you pick vice over virtue and pour money into the liquor, cigarette and gambling stocks? 

Should you invest? 

Vice stocks tend to exhibit strong performance even in dire economic circumstances as people don't usually give up on their addictions just because times are tough. These stocks have even been found to outperform the broader markets during traditionally tough market periods. In 2008, Merrill Lynch examined the performance of US-based alcohol, tobacco and casino stocks in all recessions since 1970, and found that while the S&P 500 fell 1.5% on an average, vice stocks rose by an average of 11%. These companies tend to generate huge cash flows year after year, enabling them to dole out generous dividends to shareholders. The profit margins are also on the higher side in most of the product categories. If you are an astute investor, put your money in them for investing is all about making more money. 

Where you can invest 

Vice stocks as a category is already a familiar theme in the western countries. In fact, investors in the US have been betting on dedicated 'vice funds' for a while now. There is no such fund for investors in India, but here are some vice stocks for your consideration: 

Tobacco 

ITC: Though the company has evolved into a conglomerate with multiple businesses, ITC (formerly the Indian Tobacco Company) remains at its core a tobacco and cigarettes manufacturer and continues to derive nearly 80% of its profits from this segment. Boasting a wide range of popular cigarette brands, ITC enjoys a stranglehold in the domestic market with a market share of about 80%. The reports that the government is mulling curbs on import of cigarettes and that it may opt for a complete ban on foreign participation in wholesale trading in tobacco and cigarettes means that it will benefit this dominant market player. Over the years, ITC has successfully managed to alter its image in the eyes of the public and is known more as an FMCG player today. Sanjay Manyal, analyst at ICICI Securities, says, "ITC's dependence on the cigarettes division will come down over the next few years. We are positive on the revenue growth in its FMCG business." 

    The company has been delivering stellar financial performance for years now. As a result, the stock price has shot up quite a bit, and now trades at 36.5 times its earnings. 

VST Industries: The Hyderabad-based VST Industries (erstwhile Vazir Sultan Tobacco Company) is another prominent player in the country's cigarette and tobacco market. Notwithstanding the competition from ITC, VST Industries has managed to put up a good show, enjoying an enviable foothold in south India. The company offers its products under the brand name, Charminar. The strategy of launching new brands in valuefor-money segments has helped it corner demand and grow volumes despite the steep increase in prices over the years. 

    VST has managed a consistent sales growth of over 20% over the past two years. The stock has seen significant activity of late, with several mutual funds buying into the company. The investment by mutual funds rose from 2.5% in June 2010 to 10.4% by the end of March 2012. During this period, the stock price jumped 344% from 540 to 1,860. 

    Some of the other prominent listed firms in the tobacco segment include the foreign player Godfrey Phillips India (Four Square and Marlboro), and local manufacturers Kothari Products (Pan Parag Pan Masala) and Golden Tobacco (Panama and Chancellor). 

Gaming 

Delta Corp: The only listed casino operator in India, Delta Corp, has also shown an interest in the real estate and hospitality industry. Among the six offshore casino gaming licences issued by the Goa government, Delta owns and operates three-Casino Royale, Casino Caravela and King's Casino (to be launched soon). These casinos operate from luxury cruise ships, offering fine dining and entertainment experience, apart from gaming. Delta Corp's casinos offer customers a variety of international games like baccarat, poker, roulette, blackjack, etc. With the addition of the third casino, Delta Corp will see a multi-fold increase in gaming positions-from the current 700 to around 2,200-and a boost to its revenues over the coming year-and-a-half. Vishal Jajoo, senior analyst at Nirmal Bang, states, "We expect the company to witness a phenomenal increase in revenue as well as earnings due to the almost five-fold rise in gaming positions over the next 12-15 months." 

    In the future, the company intends to consolidate its position by adding casinos to its existing portfolio in Goa. It is also planning to expand its gaming and entertainment presence in other destinations as and when they open up in the near future. With its first mover advantage in an industry with high entry barriers and low penetration, Delta Corp is well-positioned to benefit in the long run. However, increased regulation and changes in gaming tax rates could pose a risk to the business. The stock price has witnessed a sharp correction of late and presents a good entry point for investment in the long term. 

Liquor 

United Spirits: The United Breweries Group's flagship company, United Spirits (USL), remains on a strong growth curve despite the mounting problems of the promoter company's other subsidiary, Kingfisher Airlines (USL does not hold any stake in KFA directly or indirectly). With its sales touching 127 million cases last year, United Spirits enjoys a dominant 42% market share. The company's focus on premium products in its portfolio has worked well and its foray in the emerging markets in Africa and Southeast Asia will give it a further boost. 

    While demand remains strong, the biggest concern for the company is its huge debt of nearly 8,000 crore. So it is looking at deleveraging its stretched balance sheet by raising around $225 million ( 1,260 crore) through FCCBs to reduce a part of its debt. USL's stock price has also taken a beating due to the storm over Kingfisher Airlines. However, investors seem to have overreacted to the developments. Based purely on its fundamentals, analysts expect the stock to be rerated upwards. Sharan Lillaney, analyst at Angel Broking, says, "We believe the impact of KFA's performance has already been reflected in USL's stock price and it is now expected to be rerated based solely on its fundamental performance." 

    Apart from United Spirits' sister concern, United Breweries, the other listed players in this market include Globus Spirits, GM Breweries, Pioneer Distilleries, Tilaknagar Industries, and Indage Vintners.