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Why You Should — And Shouldn’t — Invest In British American Tobacco plc, Imperial Tobacco Group PLC And Diageo plc

Today I am looking at the perks and the pitfalls of investing in cigarette giants British American Tobacco (LSE: BATS) and Imperial Tobacco Group (LSE: IMT), and beverages behemoth Diageo (LSE: DGE).

Barnstorming brand power

The double-whammy of reduced spending power in key emerging markets, and rising health concerns surrounding cigarette and alcohol consumption, has had a worrying effect on volumes at British American Tobacco, Imperial Tobacco and Diageo in recent times.

British American Tobacco reported just last week that total cigarette volumes declined 1.4% during 2014 to 667 billion sticks, and follows Diageo’s interim results which showed physical drink demand slide 1.9% during July-December.

Still, the results underlined the terrific pricing power wielded by these firms — British American Tobacco saw revenues at constant currencies rise 2.8% last year to £15.7bn, while Diageo saw organic net sales remain broadly flat despite the effect of falling volumes.

The strength of the cigarette maker’s blue-chip labels such as Dunhill and Lucky Strike allows the business to effectively raise prices to mitigate the effect of declining packet sales, just like Imperial Tobacco which counts West and Davidoff amongst its key brands. Meanwhile Diageo can rely on the likes of its Johnnie Walker whiskey and Guinness stout labels to drive revenues skywards.

Legislators upping the ante

However, legislators around the world are ramping up activity to boost their pro-health agendas, a trend which could have a devastating effect on sales across the tobacco and beverage sectors looking ahead.

The British Parliament is due to vote this month on whether to introduce plain packaging in the country, measures which would follow moves made by Australia in 2012 and which are being mooted in other markets. British American Tobacco has already threatened legal action should UK members vote to pass the bill.

Diageo is also facing a raft of other adverse legislative moves, from the establishment of minimum alcohol prices in Ireland through to discussions concerning a ban on drink sales on UK trains. Of course these measures are fairly modest versus the crippling laws facing the tobacco industry, but represent the creeping progress of legislators on curbing the profitability of drinks and cigarette producers.

Developing markets set to drive demand

Still, the jaw-dropping sales potential in emerging markets should still power revenues higher in the coming years. Not only are legislative pressures in these regions not as pertinent as those seen in the West, but a backcloth of rising personal disposable incomes and population levels is driving demand for luxury consumer goods through the roof.

As I have mentioned, shoppers have felt the pinch during the past year on the back of wider macroeconomic problems, and this has been a particular problem in new territories. But Diageo’s investment in India’s United Spirits and China’s Shui Jing Fang shows the confidence the company has in future alcohol demand from Asia.

And in recent days British American Tobacco announced plans to purchase the near-25% stake it doesn’t already hold in Brazil’s largest cigarette manufacturer, Souza Cruz, for £2.3bn. Latin America is the home to the vast majority of the world’s smokers, making the region a happy hunting ground for the industry’s major players.

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Royston Wild owns shares of Imperial Tobacco Group. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.