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Should You Be Investing in Tobacco Companies Right Now?
Posted by: Federico Zaldua (IP Logged)
Date: September 4, 2013 05:32PM

I have always been attracted to consumer goods companies. They operate in businesses with huge barriers to entry. Hence, those companies that were able to attain high shares of their respective markets, are (almost always) very profitable. The tobacco space is one of those very concentrated sectors with huge margins and amazing barriers to entry. Here I want to take a look at who is now investing in international tobacco companies. Maybe you should follow suit.
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International Tobacco Champion[/size]

Philip Morris International (PM), which is an Altria (MO) spin-off (2008), owns more than 16% of the total international cigarette market outside of the United States (29% excluding the People’s Republic of China and the United States). Despite holding control of a great business, Philip Morris International's shares are slightly down year to date. The reason can be found in the company's second-quarter results, which fell short of expectations. Volume growth (excluding from the Philippines) did not improve as expected. Nevertheless, stagnant volume growth can be explained through non-permanent reasons: (1) Sharp decline in Russia following tax led price increases, (2) Problems with illicit trade in a number of markets such as Turkey and (3) A still weak market in Europe. That said, the company's guidance for the current financial year is still aggressive. Philip Morris International expects to increase EPS by as much as 12%. This leaves a lot to catch up in the second half of the year.

Some great investors such as Joel Greenblatt (Gotham Capital) or Ray Dalio (Bridgewater Associates) believe in the company's ability to deliver targeted results. Philip Morris International indeed seems cheap, trading at 15 times earnings while paying a 4% cash dividend yield.
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Catching European bargains[/size]
Tweedy Browne (also an investor at Philip Morris International) has been very active at British American Tobacco (BTI). The reason? Valuation. With management providing a reassuring outlook for the second half of the year (thanks to a strong pricing environment), British American Tobacco trades at 14.5 times earnings, a 20% discount to other consumer staples. Even when British American Tobacco has been growing organically at a slow pace (+4% in the first half of the year), the price-volume mix makes this company a clear long. I would expect a +5.5% price mix increase for the second half of the year after a +7.4% increase in the first half. When we add to this environment the on-going cost savings in place, we get the significant margin expansion that the company could achieve in the first half of 2013 (+1%). I would follow Tweedy Browne on this great company which is currently paying a 4.15% cash dividend yield.
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Consumer goods companies are great ways to protect your savings from inflation. They generate steadily growing cash-flows and, hence, pay growing dividends to their shareholders. At the current valuation level, I would follow Tweedy Browne, Gotham and Bridgewater Associates. Go long Tobacco!

Guru Discussed: Tweedy Browne: Current Portfolio, Stock Picks
Ray Dalio: Current Portfolio, Stock Picks
Stocks Discussed: PM, MO, BTI,
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