Which Tobacco Company Offers the Best Returns?

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

Tobacco companies are well known for their free cash flows, which allow them to return large amounts of cash to investors through stock repurchase programs and dividends. However, with each company providing equally impressive returns, which offers investors the most by way of cash returns?

Altria (NYSE: MO) does not offer much in the way of stock repurchases but the company offers a dividend yield of around 5%. On the other hand, Philip Morris International (NYSE: PM) has been undertaking huge stock-repurchase programs but only offers a 4% dividend yield. Having said that, underdog Lorillard (NYSE: LO) could actually be achieving the best returns as the company rapidly reduces its small free-float by well-timed repurchase programs and a good 5% dividend yield. Lastly, Reynolds American (NYSE: RAI), which offers a good 5% dividend yield and is currently in the middle of a two-and-a-half year $2.5 billion stock-repurchase program.

So where can the best returns be found?

For this analysis, I am going to be examining the companies based on the total amount of cash returned to shareholders, per share, during the period. Then I'm going to use this per-share amount to arrive at a total returned as a percentage of the average share price for the period.

Philip Morris

<table> <thead> <tr><th> <p>Billions</p> </th><th> <p>2011</p> </th><th> <p>2012</p> </th><th> <p>Q1 2013</p> </th><th> <p>Average Return</p> </th></tr> </thead> <tbody> <tr> <td> <p>Number of shares in issue (Billions)</p> </td> <td> <p>1.76</p> </td> <td> <p>1.69</p> </td> <td> <p>1.65</p> </td> <td> </td> </tr> <tr> <td> <p>Total dividend (Billions)</p> </td> <td> <p>$4.79</p> </td> <td> <p>$5.40</p> </td> <td> <p>$1.41</p> </td> <td> </td> </tr> <tr> <td> <p>Total repurchases (Billions)</p> </td> <td> <p>$5.30</p> </td> <td> <p>$6.52</p> </td> <td> <p>$1.45</p> </td> <td> </td> </tr> <tr> <td> <p>Returned per share</p> </td> <td> <p>$5.73</p> </td> <td> <p>$7.05</p> </td> <td> <p>$1.73</p> </td> <td> </td> </tr> <tr> <td> <p>Average share price</p> </td> <td> <p>$65.00</p> </td> <td> <p>$82.79</p> </td> <td> <p>$90.00</p> </td> <td> </td> </tr> <tr> <td> <p>Total returned</p> </td> <td> <p>8.8%</p> </td> <td> <p>8.5%</p> </td> <td> <p>1.9%</p> </td> <td> <p>8.3%</p> </td> </tr> </tbody> </table>

Figures in $ 

Well known for its huge stock buybacks, Philip Morris has been returning just under 8.3% a year to investors on a per-share basis. On a per-share basis, both stock repurchases and dividends meant that shareholders each received $5.73 per share in 2011 and $7.05 in 2012; based on the average share price for the year, this was a total cash return of 8.8% and 8.5%, respectively.

Altria

<table> <thead> <tr><th> <p>Billions</p> </th><th> <p>2011</p> </th><th> <p>2012</p> </th><th> <p>Q1 2013</p> </th><th> <p>Average Return</p> </th></tr> </thead> <tbody> <tr> <td> <p>Number of shares in issue (Billions)</p> </td> <td> <p>2.06</p> </td> <td> <p>2.02</p> </td> <td> <p>2</p> </td> <td> </td> </tr> <tr> <td> <p>Total dividend (Billions)</p> </td> <td> <p>$3.22</p> </td> <td> <p>$3.40</p> </td> <td> <p>$0.87</p> </td> <td> </td> </tr> <tr> <td> <p>Total repurchases (Billions)</p> </td> <td> <p>$1.32</p> </td> <td> <p>$1.08</p> </td> <td> <p>$0.09</p> </td> <td> </td> </tr> <tr> <td> <p>Returned per share</p> </td> <td> <p>$2.20</p> </td> <td> <p>$2.22</p> </td> <td> <p>$0.48</p> </td> <td> </td> </tr> <tr> <td> <p>Average share price</p> </td> <td> <p>$26.30</p> </td> <td> <p>$31.60</p> </td> <td> <p>$34.00</p> </td> <td> </td> </tr> <tr> <td> <p>Total returned</p> </td> <td> <p>8.4%</p> </td> <td> <p>7.0%</p> </td> <td> <p>1.4%</p> </td> <td> <p>7%</p> </td> </tr> </tbody> </table>

Figures in $ 

Altria has not been buying back as much stock as Philip Morris, but the company has still returned around 7% to investors annually. On a per-share basis, both stock repurchases and dividends meant that shareholders each received $2.20 per share in 2011 and $2.22 in 2012. Based on the average share price for the year, this was a total cash return of 8.4% and 7%, respectively.

Reynolds American

<table> <thead> <tr><th> </th><th> <p>2011</p> </th><th> <p>2012</p> </th><th> <p>Q1 2013</p> </th><th> <p>Average Return</p> </th></tr> </thead> <tbody> <tr> <td> <p>Number of shares in issue (Billions)</p> </td> <td> <p>0.582</p> </td> <td> <p>0.565</p> </td> <td> <p>0.551</p> </td> <td> </td> </tr> <tr> <td> <p>Total dividend (Billions)</p> </td> <td> <p>$1.20</p> </td> <td> <p>$1.30</p> </td> <td> <p>$0.33</p> </td> <td> </td> </tr> <tr> <td> <p>Total repurchases (Billions)</p> </td> <td> <p>$0.28</p> </td> <td> <p>$1.10</p> </td> <td> <p>$0.33</p> </td> <td> </td> </tr> <tr> <td> <p>Returned per share</p> </td> <td> <p>$2.55</p> </td> <td> <p>$4.25</p> </td> <td> <p>$1.18</p> </td> <td> </td> </tr> <tr> <td> <p>Average share price</p> </td> <td> <p>$36.60</p> </td> <td> <p>$41.10</p> </td> <td> <p>$44.30</p> </td> <td> </td> </tr> <tr> <td> <p>Total returned</p> </td> <td> <p>7.0%</p> </td> <td> <p>10.3%</p> </td> <td> <p>2.7%</p> </td> <td> <p>9.3%</p> </td> </tr> </tbody> </table>

Figures in $ 

Reynolds American is much smaller than both Altria and Philip Morris but it would appear that the company's well-placed mix of buybacks and a decent dividend payout have actually resulted in better returns for investors. The company has returned around 9.3% to investors annually (based on Q1 2013, the company is set to return an annualized 10.8% this year.) On a per-share basis, both stock repurchases and dividends meant that shareholders each received $2.55 per share in 2011 and $4.25 in 2012; based on the average share price for the year, this was a total cash return of 7% and 10.3% respectively.

Lorillard

<table> <thead> <tr><th> <p>Millions</p> </th><th> <p>2011</p> </th><th> <p>2012</p> </th><th> <p>Q1 2013</p> </th><th> <p>Average Return</p> </th></tr> </thead> <tbody> <tr> <td> <p>Number of shares in issue (Billions)</p> </td> <td> <p>417</p> </td> <td> <p>389</p> </td> <td> <p>378.6</p> </td> <td> </td> </tr> <tr> <td> <p>Total dividend (Billions)</p> </td> <td> <p>$723</p> </td> <td> <p>$807</p> </td> <td> <p>$209</p> </td> <td> </td> </tr> <tr> <td> <p>Total repurchases (Billions)</p> </td> <td> <p>$1,580</p> </td> <td> <p>$573</p> </td> <td> <p>$149</p> </td> <td> </td> </tr> <tr> <td> <p>Returned per share</p> </td> <td> <p>$5.52</p> </td> <td> <p>$3.55</p> </td> <td> <p>$0.95</p> </td> <td> </td> </tr> <tr> <td> <p>Average share price</p> </td> <td> <p>$35.00</p> </td> <td> <p>$40.00</p> </td> <td> <p>$39.40</p> </td> <td> </td> </tr> <tr> <td> <p>Total returned</p> </td> <td> <p>15.8%</p> </td> <td> <p>8.9%</p> </td> <td> <p>2.4%</p> </td> <td> <p>11.4%</p> </td> </tr> </tbody> </table>

Figures in $ 

Lastly, Lorillard, which appears to have given shareholders the best returns out of the whole group. The company has returned around 11.4% to investors annually (based on Q1 2013, the company is set to return an annualized 9.6% this year.) On a per-share basis, both stock repurchases and dividends meant that shareholders each received $5.52 per share in 2011 and $3.55 in 2012; based on the average share price for the year, this was a total cash return of 15.8% and 8.9%, respectively.

But will these returns continue?

<table> <thead> <tr><th> <p>Company</p> </th><th> <p>Philip Morris</p> </th><th> <p>Altria</p> </th><th> <p>Reynolds American</p> </th><th> <p>Lorillard</p> </th></tr> </thead> <tbody> <tr> <td> <p>Net operating cash flow</p> </td> <td> <p>$1360</p> </td> <td> <p>$1790</p> </td> <td> <p>$945</p> </td> <td> <p>$699</p> </td> </tr> <tr> <td> <p>Cash dividends paid</p> </td> <td> <p>$1410</p> </td> <td> <p>$886</p> </td> <td> <p>$326</p> </td> <td> <p>$209</p> </td> </tr> <tr> <td> <p>Stock repurchased</p> </td> <td> <p>$1450</p> </td> <td> <p>$91</p> </td> <td> <p>$325</p> </td> <td> <p>$149</p> </td> </tr> <tr> <td> <p>Total Retuned</p> </td> <td> <p>$2860</p> </td> <td> <p>$977</p> </td> <td> <p>$651</p> </td> <td> <p>$358</p> </td> </tr> <tr> <td> <p>Cover by cash flow</p> </td> <td> <p>0.5x</p> </td> <td> <p>1.8x</p> </td> <td> <p>1.5x</p> </td> <td> <p>2x</p> </td> </tr> </tbody> </table>

Figures taken from first quarter results; in $ millions

Looking at company cash flows for the first quarter of this year, it would appear that three out of the four companies have plenty of room to continue these high shareholder returns. Indeed, each company, apart from Philip Morris, is able to cover its cash returns to shareholders at least one-and-a-half times by net operating cash flow.

However, Philip Morris is unable to wholly cover its shareholder returns. That said, as I have explored here, Philip Morris is strategically borrowing in order to buyback stock, a strategy that is benefiting the company and generating improving returns without putting a drag on the company's finances.

Conclusion

It would appear that on a yearly, per-share basis, Lorillard has returned the most cash to investors. As the smallest company in the group, this does come as a surprise but it also highlights the management's effectiveness, which should be set to continue.

So overall, for investors who are looking for large returns from their investments, Lorillard looks to be the company to turn to.

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Fool contributor Rupert Hargreaves owns shares of Altria Group. 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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