The Giant of Vices: A Look into the Tobacco Sector
Muhammad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Although the cigarette industry has been in a decline for the past few years, it is showing promise of a recovery. The recession has been an unexpected boon for the industry, with the economic and job related stress increasing the consumption of tobacco products. The government has increased taxes and other levies in a largely ineffective attempt to discourage smoking. They have, so far, been unable to diminish the profit margins in the industry.
The tobacco sector is full of various companies; however, three stand out above all the others: Altria (NYSE: MO); Lorillard (NYSE: LO); and Reynolds America (NYSE: RAI). Of the three, Altria is the clear leader of the pack.
Lorillard is the third largest cigarette producer in the United States. The company has great operating margins of almost 46%, and earns over a billion dollars as net income. However at 16.42, it has a lower P/E than Altria. The company is also quite a bit smaller than Altria; it has a total market capitalization of 'only' $17 billion. Furthermore, the company also has a few legal cases in the US Court, including some against the FDA. This is over the plans for the inclusion of health warnings displayed prominently on their product packs. Ultimately, this stock should most likely be avoided by investors. This is due to the multiple regulatory frameworks that come into play surrounding the company.
Reynolds America is another major manufacturer of tobacco products in the United States. It has a net income of over $1.4 billion. Its EPS is $2.4 more than Altria, but its net operating margins are quite a bit lower, at around 30%, as compared to Altria's 38%. The company has a lower P/E ratio than Altria, however, at around 17.
On another vein, the company recently lost a case in the Supreme Court. It was over damages relating to “conspiring to hide information about dangers of smoking.” This case could possibly open the way for similar cases, there is a possibility that Reynolds America could face serious losses through the potential litigations.
Altria, on the other hand, has a large budget for marketing and advertising. This is used to lessen the influence of legal and regulatory battles against tobacco. It is also a large stake holder.
It has its fingers in a lot of different markets. It owns subsidiaries, as of December 31, 2011, in cigarettes and some smokeless products (Phillip Morris USA), machine made cigars and pipe tobacco (John Middleton), the sale and manufacture of wine and smokeless products (UST LLC), and finance leases (Phillip Morris Capital Corporation). It also holds a voting interest in the second largest brewer in the world by revenue (SABMiller) and a 27% economic interest in the company.
In layman's terms, the company is involved in segments that concern the influenced and rich and something that can only be a positive.
It has a very low beta of around 0.4 and a low market capitalization of around $61.9 billion. This makes it one of the biggest companies in the industry. The company has a revenue growth of around 5% and an operating margin of 38%. This makes it very lucrative for shareholders.
The company has earnings per share of around $1.64; this is well below the industry average of $2.40 while its P/E is 18.54. This is just about the same as the rest of the industry. Its return on equity is around 11.35% and its dividend yield is $5.30. There seems to be quite a few points in its favor for creating good returns.
Its subsidiaries are also showing great improvement. Phillip Morris, USA has been profitable, despite the regulatory action against tobacco. With the introduction of new products like “Marlbolo Black” and “Special Blends,” the “Marlbolo” brand is growing stronger. Its financial subsidiary, PMCC, has investments in power generation, finance leases and manufacturing equipment and facilities.
To continue, the cigarette portion of the company has captured around 40% of the US market. This generates around 80% of their revenue and it also has a ROE of around 76%. The diversification into wine, financial sectors and smokeless tobacco products, which are quickly gaining popularity, has only been an advantage for the company.
Over the last four years, the company has reduced its costs by $1 billion. By the year 2013, it targets another $400 million and this will boost its profitability even further.
Altria has a net income of over $3.3 billion per annum. It also has a very good cash flow of $956 million.
For all of the reasons listed, this stock is a good choice for people looking to invest in the tobacco sector. However, it is trading at a premium; so, it would be a good idea to wait until there is a dip in the market. The company is likely going to buy between $26 and $28 and for this reason, it is a good investment for those who are willing to risk their money for some high returns.
muhammadbazil has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. If you have questions about this post or the Fool’s blog network, click here for information.