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Time to Relax: A Smoke?

October 08, 2013 | About:
Victor Selva

Victor Selva

9 followers
The tobacco industry is extremely competitive, but consumers´ loyalty is a very important characteristic. Although in times of recession some consumers switch to cheaper brands, markets in which population grows are still considered key drivers for growth. Strict anti-smoking regulation, taxation and litigation represent high barriers to entry, which are attractive for well-known brands. So let's take a look at two companies in the tobacco sector and see which one is doing better and thus stands as the best investment.

Philip Morris International Inc. (PM) manufactures and markets cigarettes outside the U.S. in 180 countries. The company´s plan is to introduce new packaging, new blends and other line extensions. A key driver of the company is the strong market share and the economies of scale. Also, the company has combated unfavorable tax regulations with price increases, showing a good price-elasticity.

Strong International Presence

Philip Morris is a dominant player in the EU and also holds leading positions in Eastern Europe, the Middle East and Africa, and Asia. Algeria, for example, has the four largest GDP in Africa and a population of 38.5 million, where people in that country smoke nearly 30 billion cigarettes per year. Asian operations will continue to be an engine for the firm's future growth, region that contributed to more than a third of operating companies’ income. Emerging markets are considered key markets; countries like India, Bangladesh, and Vietnam are potentially growth markets. In China, although the cigarette market is like a monopoly, the company entered into a joint venture with China National Tobacco to cross-sell products.

In terms of valuation, the stock sells at a trailing P/E of 16.9x same as that of the industry average. Analysts’ expectations imply a forward P/E of 14.46. For the second quarter fiscal year 2013, earnings of $1.3 per share missed the Zacks Consensus Estimate.

Looking the financials, the company has as good cash that allow the company to pay out earnings to current shareholders. Since 2008, Philip Morris has returned to its shareholders $24 billion as dividends. Also, the company repurchased shares during the same period for $27.9 billion. Morris has increased its quarterly dividend every year showing commitment to investors.

A Great Follower

Investors can have another option of investing in the tobacco sector with British American Tobacco PLC (BTI). Also selling tobacco products in 180 countries, the company holds leadership positions in around 50 of them. Brands like Dunhill, Kent, Pall Mall and Lucky Strike are well known and have been gaining share over the past several years.

British American also has meaningful equity holdings in two other publicly traded tobacco companies. The company has a 42% stake in Reynolds American RAI, which is the second-largest U.S. and owns 31% of ITC Limited, India's largest cigarette company.

Multiples are very similar to the ones that show Philip Morris. Its P/E multiple, on a trailing-12 month basis, is 16.2 and the forward P/E multiple is 13.85. A company characteristic is that demonstrate its commitment to return cash to investor in the form of dividends. The current dividend yield is 4.21%, which is considered good to protect the purchasing power. The company will continue to pay out two thirds of its adjusted net income as dividends.

Final Comment

Governments are imposing restrictions on tobacco companies to reduce smoking with the aim of decline cigarette consumption. Also, imposing higher taxes are a constant risk for tobacco manufacturers that led companies to increase prices. I believe that Philip Morris is better positioned because it has strong brands, global reach, and the capacity to increase prices that should more than offset volume declines.

In my point of view, Philip Morris appears to be attractively priced and a buy opportunity.

Hedge fund gurus like Joel Greenblatt, Steven Cohen, Jeremy Grantham and Ray Dalio added this stock to their portfolios, and I would advise fundamental investors to consider adding this stock to their portfolios as it seems to be an attractive option for investors.

Disclosure: Victor Selva holds no position in any stocks mentioned.


Rating: 4.1/5 (16 votes)

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