How to Profit Off of a New Trend

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Tobacco companies are facing more headwinds than ever before, including regulation, taxation, and litigation. The FDA is enforcing regulatory control and cigarette sales volume has declined. Smoking cigarettes also now comes with a social stigma.

All of these headwinds would lead one to think that this industry should be avoided at all costs. In this case, however, many tobacco companies have been wise enough to realize that when there’s a roadblock you should take a detour.

MarkTen launch

Altria Group (NYSE: MO) owns Nu Mark, and Nu Mark is expected to launch its MarkTen e-cigarette brand this month. This is an important move for Altria, as the popularity of e-cigarettes is growing at a rapid rate, while traditional paper cigarettes continue to see volume declines.

In 2011, industry-wide e-cigarette sales totaled approximately $500 million. This year, e-cigarette sales are expected to total $1 billion. This type of growth isn’t common, especially in a weak economy. And when you find this type of growth, you might want to consider jumping on the bandwagon as an investor.

The question for Altria is whether it will become a big player in the e-cigarette market. As of right now, another company dominates market share. We’ll get to that soon. First, let’s focus on Altria.

Altria has a market cap of $71.29 billion, making it the largest company covered in this article. The company's revenue declined in 2011, but bounced back in 2012. Altria is always profitable, but earnings growth has been inconsistent. The 4.90% yield is nice, though similar yields can be found throughout the industry. What makes Altria so appealing is its diversification. It sells cigarettes, smokeless tobacco products, wine, and more.

In the second quarter, revenue for smokeable products declined 3.8% year over year, but revenue for smokeless products jumped 7.5%. The latter was a result of higher volume and pricing. Revenue for wine also increased 7%, mostly thanks to a higher shipment volume.

Altria Group has an effective cost-cutting program in play. At the same time, it’s in the middle of a $300 million share buyback program. Both of these programs are positives for investors.

Overall, Altria looks to be a company that’s making wise moves. With popular brand names like Marlboro, Copenhagen, Skoal, Red Seal, and Husky, it should be a decent investment going forward. A better option might exist, however.

Muse for Vuse

Reynolds American (NYSE: RAI) has a market cap of $27.63 billion, making it a much smaller company than Altria.

Reynolds American also owns RJ Reynolds Vapor Company, seller of Vuse e-cigarettes. Vuse has a patented vapor technology, and its popularity consistently increases. The company also sells Camel SNUS (mint-flavored smokeless tobacco) and Zonnic (nicotine replacement therapy gum.)

Reynolds American aims to save $70 million annually through 2015. It plans to use that capital for innovation.

It would seem as though Reynolds American has everything going for it, and its recent moves might lead to future success. While earnings have consistently improved over the past three years, however, revenue has declined over the past two years.

Despite Reynolds American setting up for future industry trends (and yielding 5%), the company’s lack of consistency on the top line don’t might not make it the best option in the group.

Small packages

Lorillard (NYSE: LO) has a market cap of $16.16 billion, making it the smallest company of this group by far. It also has the biggest dreams.

A dream is nothing but a dream if there isn't a plan to make it real, but Lorillard has put a plan into action. The company had the foresight to predict the increasing popularity of e-cigarettes, and that led it to acquiring Blu e-Cigs last year for $135 million. Considering that Blu e-Cigs currently own 40% of e-cigarette market share, this acquisition was a big winner.

Lorillard also owns popular cigarette brand Newport. Unlike most tobacco companies, Lorillard's net cigarette sales increased 1.4% in the second quarter. Volume was still low, but higher selling prices made up for the lack of volume. Lorillard has been making small market share increases in different areas. Though they're only small increases, it’s better than the alternative.

What makes Lorillard very appealing is that, unlike the aforementioned companies, its revenue and earnings have consistently improved annually. Lorillard currently yields 5.10%, and share buybacks are commonplace.

The big concern here is that the FDA is expected to come down hard on menthol-flavored cigarettes; this would hurt Newport Menthol sales. At the same time, Lorillard is growing faster in the e-cigarette market than its peers.

Conclusion

All three companies sell an addictive product, and all three have prepared for changing industry trends. Altria is likely to be the most resilient investment thanks to its sheer size and broad diversification. Reynolds American has been aggressive with its innovation, giving it the potential to reward shareholders in the near future. Lorillard is ahead of the pack in the rapidly-growing e-cigarette market, giving it the most upside potential. Lorillard is also likely to be the least resilient to broad market corrections, however. The correct investment, of course, depends on your investing strategy and time frame.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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