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The Smokeless Tobacco Segment: An “ECig” Growth Opportunity

November 03, 2013 | About:
victorselva

victorselva

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In a previous article we saw that the tobacco industry is extremely competitive and consumers´ loyalty is a very important characteristic. Strict anti-smoking regulation, taxation and litigation set high barriers to entry. So now let's take a look at two other companies in this sector and see which one is doing better and thus stands as the best investment.

On July 30, 2004, R.J. Reynolds Tobacco Co. merged with Brown & Williamson, the U.S. operations of British American Tobacco, to form a new publicly traded company, Reynolds American, Inc. (RAI). The firm is the second largest U.S. cigarette manufacturer and owns fifty percent of the top brands. The company's leading products are its Camel, Kool, Pall Mall, Doral and Winston brand cigarettes.

Three categories

Reynolds' market share has declined since 1994. In order to improve profitability and regain market share, the firm establishes three categories. The first category is the investment brand (Camel and Pall Mall) which receives the majority of resources to promote market share growth. Then, the selective support brands category (Kool, Winston, Salem, Capri, Doral and Misty), receive less support to optimize profitability; and the remaining brands are included in a category called non-support brands. Although the company's support brands and nonsupport brands categories have lost significant ground due to lack of marketing, Camel maintained its market share and Pall Mall has quadrupled in the last 7 years.

Smokeless Tobacco Products

New mint flavors like Camel SNUS offers fewer risks because smokers are at far less of a risk of cancer than traditionally ones and some experts even argue that SNUS can help people quit smoking. Additionally, the firm focuses on e-cigarettes: are battery-powered devices that heats a liquid nicotine solution in a disposable cartridge and create a vapor that is inhaled. It gives the user the sensation of a traditional cigarette but removes from the equation the harmful effect of smoke (plus it is seen as a more socially acceptable alternative).

Valuation

In terms of valuation, the stock sells at a trailing P/E of 18.2x, trading at a premium compared to an average of 16.9x for the industry. Analysts’ expectations imply a forward P/E of 15.15. To use another metrics, its price-to-book ratio of 5.5 indicates a slight premium versus the industry average of 5.42x and the price-to-sales ratio of 3.46x is also slightly above the industry average of 3.37x.

The Dividend-Paying Machine

Altria Group Inc. (MO) through its subsidiaries, engages in the manufacture and sale of cigarettes, smokeless products, and wine in the U.S. and internationally. It is the largest U.S. cigarette producer with roughly 50% share.

Smokeable Segment

It is not a coincidence that Marlboro is the dominant cigarette brand in the U.S. The major reason is the quality that Marlboro´s cigarette offers to smokers. With almost 42% of market share the company introduced new brand architecture for example, a new advertising strategy targeting young future smokers.

Smokeless Segment

In 2006, the company entered the smokeless tobacco market with the introduction of Taboka Tobaccopaks, a dry tobacco product. The Copenhagen and Skoal brands maintain leadership positions (combined enjoy almost 50% share of the smokeless tobacco market). With respect to operating margins, they have grown at an annual compounded rate of 14.9% for the last three years and I believe this business will increase during the next decade.

Its P/E multiple on a trailing-12 month basis is 17.2 and the forward P/E multiple is 14.56. An interesting feature of the company is its proven commitment to returning cash to investors. The current dividend yield is 4.9%, which is considered high enough to protect the purchasing power.

Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: The return on equity.

Company ROE Compared to Industry Mean (=19)
Reynolds 24.2 Above
Áltria 131.9 Above


It is very important to understand this metric before investing in a high-growing company.

Final Comment

The decline in cigarette consumption is nothing new. Over the past decade, volumes have been declining in the U.S. at a rate of 3 to 4% annually. In response to changing consumer demands, both companies have been introducing constant innovations to their product lines. It seems that smokeless tobacco products will be the next generation to extend their portfolios and create loyalty amongst their target consumers.

In my point of view, Altria appears to be attractively priced and a buy opportunity. Hedge fund gurus like Joel Greenblatt, Steven Cohen, James Barrow and Tom Russo added this stock to their portfolios, and I would advise fundamental investors to consider adding this stock to theirs as well.

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


Rating: 4.4/5 (7 votes)

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