My Favorite Tobacco Stock Is…Intel?

Yes, you read that correctly. My favorite “tobacco stock” is Intel Corp (INTC).

Lest you think I’ve lost my mind, I am aware that Intel does not sell or market cigarettes or other tobacco products. Intel is the world’s premier designer and manufacturer of computer processors.

But while Intel is not a tobacco company, it most certainly is a tobacco stock, or at least it shares many of their characteristics.

This requires a little explaining. If you’ve read some of my past posts, you are probably familiar with my reasons for liking tobacco stocks over the long haul, even if I recommend avoiding them at current prices (see “The Price of Sin” and “Time to Stop Bogarting Cigarette Stocks”). Because of the social stigma associated with vice investments like tobacco, alcohol and firearms, many institutional investors shun them, either by choice or by socially-responsible investment mandate. This causes sin stocks to be priced as perpetual value stocks, with the low valuations and fat dividends that this entails.

Well, I admit, in this particular respect Intel has nothing in common with tobacco stocks (even if it is priced like one at the moment). It’s hard to find a scale by which Intel would be considered socially irresponsible. But let’s take a look at some of the other characteristics that make tobacco stocks—and Intel—interesting.

Tobacco companies have gargantuan barriers to new competition—what Warren Buffett might call an unassailable moat. Given the legal and political risk and the size and scale needed to deal with both, it would be next to impossible to start a new tobacco company now. You would need infinitely deep pockets and decades’ worth of political connections. As a result, Big Tobacco has become an entrenched oligopoly in which a handful of players—such as Altria (MO), Reynolds American (RAI) and Lorillard (LO)—completely dominate.

But even if you could start a new tobacco company, why would you? It’s not exactly a business with a bright future. In the developed world, tobacco is a business in steady but terminal decline.

This brings me back to Intel. I’m actually in the minority among investors at the moment in that I see a bright future for Intel. No, they haven’t figured out mobile yet, but they will. As mobile devices become more and more sophisticated, they will need the power than only Intel can provide. And there is also the server business, which accounts for roughly a quarter of Intel’s revenues. Ironically, while Intel has yet to really break into mobile, its server business has benefitted handsomely as the mobile revolution has created greater demand for cloud services.

Yet this is not how the market views Intel right now. No, Intel is a company resigned to gentle decline, as its core PC market inevitably shrinks. From the way Intel bears talk, PC users are disappearing from polite company faster than smokers, forced to type on their physical keyboards in alleys behind buildings or in doorways.

For the sake of argument, let’s assume they’re right. Intel would still be a buy at current prices.

As the Big Tobacco has proven for decades, companies in declining industries can make excellent investments under the right conditions. If you have a dominant market position (think back to Warren Buffett’s “moats”), a conservative balance sheet, and have ample cash flow for share repurchases and dividends, you can do quite well by your investors even in a shrinking market. It’s worked for Big Tobacco investors, and it will work for Intel investors as well.

At just 9 times earnings, Intel is priced significantly cheaper than any major tobacco stock, and its dividend is competitive at 4.3%. I might add that Intel’s dividend has risen by over 40% in the past two years and that its dividend still only accounts for 37% of (depressed) earnings.

Buy Intel and reinvest your dividends. If I am right, Intel will regain its place among America’s most reputable growth stocks. But even if I’m wrong, Intel is positioned to offer “tobacco like” returns for the foreseeable future.

Disclosures: Sizemore Capital is long INTC