Buy Popular Tobacco Stocks for Safety, Not Value

By David Gould - August 21, 2012 | Tickers: MO, PM, RAI | 0 Comments

• Email
• Print

With the economy in a state of limbo, tobacco is one of the most attractive sectors to invest in from a safety perspective. Altria (NYSE: MO), Philip Morris International (NYSE: PM), and Reynolds American (NYSE: RAI) may all trade at a premium to the S&P 500's current PE multiple of around 15.4x. All three of these producers provide attractive dividend yield and growth prospects. If you are interested in emerging market exposure, go with PMI. If your taste is more in product development, consider Altria and Reynolds. The tobacco sector provides a safe defensive play against an uncertain economy, because of (1) products that are supported by inelastic and sustainsable demand and (2) shareholder-friendly capital allocation policies.

The respective dividend yields of PMI, Altria, and Reynolds are 3.4%, 4.6%, and 5.1%, respectively. A lot of the time, dividend yields are higher because of slower growth rates ahead, so let's do a quick check on the numbers. PM is forecasted for 9.9% annual EPS growth over the next 5 years (10.8% in the past 5) versus 6.1% (1.6% in the past 5) for Altria and 7% (4.6% in the past 5) for Reynolds. One would expect Reynold with stronger past growth and future expectations to have a lower dividend yield than Altria, but the market has failed to preference companies this way.

Instead the market appears to have placed a greater emphasis on brand. This is revealed by how Altria trades at a respective 21x and 14.9x past and forward earnings versus corresponding figures of 20x and 14.4x for Reynolds. But what is weird is that PMI, which was spun off from Altria, basically has the same brand as Altria and markets the same relevant products, like Marlboro, but is nevertheless at a discount to Altria.

Reynolds is similarly more of a safe investment. It will have 2016 EPS of around $3.88 based on consensus estimates. At a 17x multiple, the future stock value would be $65.96. Discounting backwards by 8% yields a present value in-line with the current stock price and consensus. Again, however, the dividend yield alone is worth an investment.

Altria will have 2016 EPS of around $2.82 based on consensus estimates. At a 17x multiple, the future stock value should be $47.94. Discounting backwards by 8% yields a price target slightly of $32.63 - slightly below the current price. According to data from FINVIZ.com, analysts rate all three of the stocks around a "hold," and are most conservative about Reynold, and most bullish about PMI.

One area where tobacco investors should be concerned is the Obama administration's potential tax hikes. Since equities are theoretically priced based on an after-tax dividend yield, some firms may lose 33% of their value when qualified dividend and capital gains taxes are hiked by roughly 164% next year. Those with the highest dividend yields, like tobacco, have most to lose given that is where much of their value is found. In the meanwhile, investors are encouraged to hold a few tobacco stocks and possibly profit if tax hikes are dismissed, as I expect them to be. While the rest of the economy is largely uncertain, tobacco stocks will bring in steady streams of income in good times and bad. If anything, smoking rates may go up during a double dip and tax hikes may be put on hold. The strong brand name companies highlighted in this article are thus recommended as more of a hedge against a volatile economy than a value play.

• Email
• Print
• Feedback