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Three Tobacco Stocks Investors Should Look Out For

September 05, 2013 | About:

Tobacco companies have always offered high dividends, and associated with strong balance sheets. The three big players in the industry are Altria Group Inc. (NYSE:MO), Reynolds American Inc. (NYSE:RAI) and Lorillard Inc. (LO). The trio has similar valuations and comparable yields. These companies hailing from an unhealthy industry are poised to continue raising their safely maintained dividends. They will find plenty of tobacco huffers in the developing world, if they can build out their international presence. Below is some insight into the three.

Altria (NYSE:MO)

Altria's Philip Morris USA holds a 50% share of the U.S. tobacco market with a 60% share in the premium brand segment. Altria, whose brands include top-selling Marlboro cigarettes, Skoal smokeless tobacco and Black & Mild cigars, also reaffirmed its 2013 full-year adjusted earnings forecast of between $2.35 and $2.41 per share.

The company holds a voting stake in brewer SABMiller, owns wine businesses and has a financial services division. The company's diversification into smokeless tobacco is crucial to promoting its growth due to the declining market for smokers in the U.S.

Philip Morris USA is Altria's domestic cigarette manufacturing company. Philip Morris remains the largest tobacco company in the United States by both revenue and volume. It owns UST, the world's largest moist smokeless tobacco manufacturer by sales. UST provides Altria with the leading smokeless tobacco brands, Skoal and Copenhagen.

It has a strong dividend growth history. With a current dividend yield of 5%, its dividend payout ratio based on consensus estimates for earnings this year is 73.3%. Next year, it is expected to earn $2.57 per share. If the payout ratio remains the same, annual dividends would come to $1.88 per share, which means a dividend increase of about 6.8%. As of March 2013, cash increased to $3.8 billion. The company is in a strong financial position based on this, and has additional cash to further strengthen this position.

Reynolds American (NYSE:RAI)

Reynolds American and Lorillard hold 29% and 10% of the market share, respectively. Reynolds American offers cigarettes under the brand names of Camel, Pallmall, Winston, Kool, etc. It produces more savings brands, making it likely to benefit from consumers switching from premium to value brands. With a current dividend yield of 5.3%, this North Carolina based company has the highest payout ratio of 78.5%. The company is expected to grow its earnings to $3.40 per share next year. As of March 2013, it had $2.8 billion of cash and generated $922 million of free cash flow. Recently, it bought back $325 million of stock paid $326 million in dividends.

Despite the fact that the company's revenues are downward trending and it has lost some of its market share, it continues to be an attractive investment from a dividend standpoint. The current P/E ratio is 19x, at a premium to its industry average.

Lorillard (LO)

The firm is a leader in e-cigarettes, electronic nicotine delivery systems that simulate the smoking experience, and gives people a healthy injection of nicotine. Lorillard's flagship cigarette Newport is by far the most popular brand of mentholated cigarettes. Earnings for American tobacco company are projected to be $3.42 per share next year. With a current payout ratio of 70.5%, the company can maintain a dividend increase of 10% next year. As of March 2013, it had $2 billion of cash on its balance sheet and free cash flow was $692 million. Revenue is expected to grow 7.5% this year and 7.4% next year. Earnings per share are pegged to rise 11% this year and 12.5% next year.

However, Altria's size and revenues put both of them at a relative disadvantage in terms of sheer heft in the industry. Both competitors are subject to the same external events, i.e. taxation, litigation and changes in popular attitudes about smoking.

Economic Downturns

The tobacco industry is heavily taxed and due to steep cigarette price increases, some consumers have switched from premium brands to value or deep-discount brands. Most of Altria's cigarette brands are classified as premium, making it more sensitive to these shifts in consumption than some other tobacco companies with more equally distributed product lines.

Cost-conscious consumers may stop smoking or downgrade to a value-priced brand during economic slumps, but most consume the same brands at the same or slightly lower level. As a result, Altria and other similar companies generally experience less of a decrease in revenues during recessions than the economy as a whole.

On a Concluding Note

With strong financial positions, it is nearly inevitable that these companies are well-placed to increase their dividends in the time to come. To choose any one of these may be a personal preference. But if I had to select it then would have been Altria, since it is, according to me, the best-performing stock for the last five decades.

With impressive top- and bottom-line growth of 6% and 7%, respectively, on average in the recent five years, it is expected that there will be growth rate of 7.5% on an average in the coming five years. It has increased its dividend for the last 44 years. The dividend growth rate was about 11.4% for the last decade.

Altria has a reputation as an income investor's staple. It has been inculcated in shareholder-friendly policies, and is expected to provide value for investors. This company has a record of healthy operating cash flows. The venture of the company into e-cigarettes will support growth in the near future. For decades, the company has pumped out steady profit growth, returning a great deal to shareholders, and is expected to do so in the near future. This makes it an attractive stock to hold on to.

Rating: 4.4/5 (9 votes)


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