Diversification Seems to be Key in Tobacco

Muhammad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

This past year, the tobacco sector has been on the receiving end of overwhelming pressure from local governments and the FDA. With all parties pushing forward with their campaigns to reduce, and if possible, totally eradicate cigarette smoking, tobacco bigwigs have been compelled to operate under increased bearish market conditions. In fact, the CDC was noted to have spent $54 million on an ad campaign to stop smoking. With all these factors in hand, Altria (NYSE: MO) has still managed to perform relatively well all year through, demonstrated by the 9 percent gain in its stock last year. Compared with its peers in the industry, Altria seemingly possesses the ability to overcome broader market conditions. What is its secret weapon?

Diversification

Altria, unlike most of its competitors, extends a more diversified package. Instead of placing all its future prospects on the cigarette business, the bigwig has established a reasonable stake in wine. As of now, Altria commands an estimated 28 percent stake in SABMiller Beer, one of the leading alcohol brands in the U.S. market. This means that Altria will always be guaranteed to rake in reasonable amounts regardless of the fashion in which anti-tobacco programs strike.

I am particularly drawn in by the comparison between Altria and Reynolds (NYSE: RAI).  The latter has performed relatively well through the year. In fact, its stock has been on an upward trajectory since the fall of 2008. This gain in its stock has been coupled with an almost similar gain in dividend, signaling the bellwether’s undisguised efforts to increase shareholder value. Numbers actually show that Reynolds’s stock has gained 35 percent since 2008. Its dividend on the other hand has edged up 39 percent over the same period.

The graph below gives a clearer picture on the same:

<img src="/media/images/user_13010/mo_large.jpg" />

As detailed in the graph, there is an apparent correlation between Reynolds’s share price and dividend payout.

Why am I skeptical over Reynolds when the past four years have demonstrated nothing short of bullishness?

While Reynolds has to some extent outperformed, its long term prospects are shrouded in uncertainty. Unlike Altria, Reynolds solely depends on cigarettes. In addition, its market is basically restrained to the U.S. This gives the edge to other canny players like Philip Morris (NYSE: PM), which incidentally has a commendable global footprint. What implications do these downsides have on Reynolds’s long term outlook? So long as Reynolds doesn’t diversify its package or reach out to other potent markets beyond the U.S., its future isn’t that guaranteed. It will probably reach a time when the cigarette maker will not be able to sustain its dividend growth considering the uncertainty that shadows the U.S. sector. This is the point where Altria has the edge.

Altria is already looking for alternate streams of revenue within the U.S. tobacco sector. Instead of solely relying on the conventional cigarette, the titan has gone ahead and established a solid footing in smokeless tobacco products. I believe that smokeless tobacco will be an unbelievably big segment in the foreseeable future; a factor that will allow Altria to rake in huge amounts in sales. Smokeless tobacco has already contributed to Altria’s sales, making up close to 10 percent of the bigwig’s top line. What’s more is the fact that Altria doesn’t face any formidable competition as far as smokeless products are concerned.

I have convictions that Altria’s current value does nothing to reflect its intrinsic value. Altria’s thickening prospects in the smokeless tobacco segment, coupled with its diversified product line, suggests that its value far exceeds the figure pegged by the market.  This presents an opportunity for value oriented investors who are looking to make huge returns in the long haul. The only possible hurdle along the way will be battling competition from Philip Morris. The bigwig has also dipped its toe into the alternative product niche with smokeless products. In addition, it is making advancement on the electronic cigarette segment. While its efforts are still in the initial stages, this may pose a threat considering its huge footprint in the global market.

Going by the third quarter earnings, Altria is evidently doing a lot to bolster its revenue in light of reduced consumption. Its top line increased 4 percent following strategic product price increases. Similarly, the management took a more prudential approach to outlays, a move that allowed the cigarette maker to increase operating income by 16.5 percent. If Altria continues managing its affairs in a similar fashion, then I am confident that it will retain its dominant position in the long haul. I believe that Altria is a good buy. Its stock price will certainly rise with time, particularly so when the market appreciates the cigarette maker’s true value.

 


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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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