E-cigarettes vs. Tobacco: Where Should You Invest?

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

Currently, the tobacco industry is in decline because cigarette consumption decreases by around 3% annually. The main reason for that is a growing awareness of the harmful health effects of smoking cigarettes. As a result, total cigarette consumption has continued on a 13-year downward trend. That is why the market for e-cigarettes might be considered the next growth play for the cigarette producers as the chart below suggests.  

Source: Statistic Brain (based on data from UBS, Wells Fargo, Tobacco Vapor Electronic Cigarette Association)

An e-cigarette is an electronic inhaler vaporizing a liquid solution into an aerosol mist. There are some key advantages of smoking e-cigarettes when compared to traditional units. There is no combustion, no smoke, no carbon monoxide, no tar or other carcinogens, no risk of fire, no second-hand smoke, and no unpleasant smell. The total costs for e-cigs can  be significantly lower on an ongoing basis than cigarettes. However, the key benefit of smoking electronic cigarettes is the ability to regulate the nicotine portion consumed. That helps to reduce nicotine concentration step-by-step if a person desires.  

Are e-cigarettes the right call for investors? Where should you invest your money out of all the options in the cigarette industry? In this article you will find the answers to these questions.

Market players

Reynolds American (NYSE: RAI) is offering a yield above 5%, which has to attract even those investors that are marginal on the negatives for the tobacco industry. The company’s famous brands include Camel and Pall Mall, which hold 8.2% and 8.7% of the U.S market share, respectively.

Since 2006, e-cigarettes have gradually become a significant part of the U.S cigarette sales. With growing advertisements, electronic cigarettes are said to have taken 1% of all cigarette sales in 2013 alone. As the second-largest cigarette producer in U.S, the company has latched onto the e-cigarette trend with the introduction of VUSE.

Altria Group (NYSE: MO) controls roughly half of the U.S. cigarette market. It is also the exclusive seller of the much-acclaimed Marlboro brand in the US. Altria also is introducing its own brand of e-cigarettes by the name of MarkTen. Sales of e-cigarettes are dependent upon increased awareness and expanded retail distribution. Altria has an advantage over its competition on both fronts due to its superior brand recognition.

Like Reynolds American, Altria provides a high yielding dividend at a very affordable price, luring investors away from the competition. However, Altria has growing competition in the form of increasing awareness regarding the harmful effects of smoking, which continue to limit the growth potential of tobacco cigarettes. Evidence of this is given in the fact that cigarette consumption continues to decline by 3% annually.

Philip Morris (NYSE: PM) sells Marlboro and other cigarettes sold by Altria Group exclusively outside the U.S. The company’s market share in the international cigarette industry stands at 28.8%. Unlike its American rivals, Philip Morris is not moving into e-cigarettes for the international markets due to low awareness and demand in the developing world.

Taking advantage of this fact, the company has expanded its volumes in countries such as the Philippines and Indonesia to offset the loss in sales volumes from the developed world. Over the past five years, the company has strengthened its financial position as it improved its cash flows by approximately 100% and capitalized on strong margins. Since 2008, the company has increased its dividend amount by 84.8%. 

Competition 

Indicator

Altria Group

Philip Morris

Reynolds American

Price/Earnings ttm

16.4

17.4

17.7

Price/Book

20.0

-34.6

5.1

Net Income Growth (3 Yr Avg.)

9.3

11.5

10.0

Revenue Growth

(3 Yr Avg.)

1.3

7.6

-0.5

Dividend Yield, %

4.9%

3.6%

5.0%

Return on Equity

120.2

-

27.1

Current Price

$36.06

$91.70

$47.64

Data from Morningstar and Financial Visualizations on June 13

Currently priced above $90, Philip Morris continues to provide investors with strong intrinsic performances as its revenue and net income growth overshadow those of its American competitors. The company is taking advantage of having untapped markets in which to allocate resources.

For Altria and Reynolds, the problem is not only having a single market in which to operate, but also a highly knowledgeable market which is increasingly shunning cigarettes. In the American e-cigarette market, the two firms will have to contend with Lorillard, which has already launched its own e-cigarette with an aggressive advertisement campaign that has allowed it to gain a majority share of the market.

Final thoughts

The American tobacco market and impending rise of the e-cigarette have a lot of risk and volatility up ahead. Keeping in mind the tough competition among Altria Group, Reynolds American  and Lorillard  in the American market, we might see a price war for e-cigarettes much similar to the one witnessed in 2001 and 2002.

Steering clear of the e-cigarette trouble, Philip Morris continues to explore developing markets and offers its enhanced cigarette range in these countries to make up for the lost sales from the developed world. In my opinion, Philip Morris offers better value, strong fundamentals and risk free growth potential. Philip Morris is a solid buy.

Tobacco companies have been under siege in the U.S. for decades, as waves of litigation, regulation, and anti-smoking campaigns have given the industry a black eye. Yet Philip Morris International focuses on overseas markets, where business prospects generally look brighter. Investors have been happy with its stock's performance, but is Philip Morris still a buy? Find out in The Motley Fool's premium research report on the company, which includes in-depth analysis of its opportunities and challenges ahead. To claim your report just click here now.


Marina Avilkina has no position in any stocks mentioned. The Motley Fool owns shares of Philip Morris International. 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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