No relief for tobacco in COVID-19 pandemicMay 18, 2020By Leah Moehlig, CFAESG Senior Research Analyst, Calvert Research and ManagementWashington - Historically, in periods of economic uncertainty, investors have flocked to defensive sectors such as consumer staples. During these times, despite a deterioration in consumer financial health, issuers within the consumer staples sector tend to generate stable cash flows, given inelastic consumer demand relative to the broader market. We have seen this phenomenon play out thus far for the COVID-19 pandemic - with a notable industry laggard: tobacco. Perhaps the health-related regulatory and consumer pressures long highlighted by ESG research have been recognized by the wider market as financially material long-term risks.While these concerns have caused tobacco companies to experience volume declines in developed markets, up until recently, this has been more than offset by increased pricing and volume growth in emerging markets. While most tobacco issuers had invested in potentially reduced risk products such as heat, not burn, tobacco and e-cigarettes, the market size of these innovations were relatively minimal. However, in 2018, the widespread popularity of vaping resulted in accelerated volume losses for combustible cigarettes. This prompted issuers within the tobacco industry to make significant investments in vaping in an attempt to capture their lost market share. Ultimately, some of these investments proved to be untimely, given the emergence of vaping-related lung illnesses and increased regulatory scrutiny to reduce youth usage. To date, tobacco issuers have not had success pivoting their businesses away from categories that experienced heightened regulatory pressure and associated legal and compliance costs.COVID-19 impactThe underperformance of tobacco companies relative to consumer staples sector peers could be a reflection of investor belief that increasing regulatory headwinds and shifting consumer preferences have resulted in an inability to generate long-term stable cash flows. Given the heightened awareness of health issues related to COVID-19, these headwinds are likely to accelerate. According to The World Health Organization, smokers are more likely to develop severe disease with COVID-19, compared to nonsmokers.2 In addition, consumer surveys indicate that the health concerns brought to light by COVID-19 have resulted in increased consumer demand for healthy products to increase immunity.3 Given the well-known detrimental health impacts attributed to tobacco use, it stands to reason consumers may be less likely to purchase tobacco products over the long term.Bottom line: Calvert has always recognized the significant health risks associated with tobacco use and has reflected these risks in our ESG research models. COVID-19 has heightened the already strong consumer demand for healthier products. If this demand persists over the long term, tobacco companies will struggle to meet consumer expectations with their current portfolios.