3 Tobacco Stocks To Consider Buying As Unemployment Ticks Up
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With the unemployment rate rising to 8.3% despite better-than-expected employment numbers, it's becoming increasingly evident that the discouraged worker effect has much to add to the macro story. The U-6 rate, which includes the number of people who have stopped looking for work, is at 15.3%. In such a fundamentally weak climate, investors should consider backing high dividend yielding companies with stable to strong future prospects. Below, I review the fundamentals of Philip Morris (NYSE: PM), Altria (NYSE: MO), Reynolds American (NYSE: RAI).
Philip Morris International
PMI trades at a respective 18.2x and 16x past and forward earnings with a 3.4% dividend yield. While this nearly guaranteed income is attractive, it is dwarfed by peers without being offset by high growth prospects. Analysts are, accordingly, reserved on the stock and rate it only around a "hold" based on data from FINVIZ.com.
During the second quarter, EPS of $1.36 slightly beat expectations despite a 1.2% decline in organic cigarette volume largely due to weakness in Japan. For 1H12, organic volume rose 1.8% as net revenues rose 6.5%. European weakness has had a meaningful impact on the bottom-line and worsened already volatile FX headwinds. Gross margins still increased by 50 bps. Management is aiming to increase EPS by 10-12% over the mid- to long-term, but analysts are forecasting below the low-end at 9.7%.
Either way, it will be hard for PMI to justify its current valuation. The 12% growth rate would put the 2016 stock price at $151.95 under a 15x multiple. Discounting backwards by 10% yields a present value roughly in-line with the current valuation. While management has reiterated its goal to repurchase $6B in shares by 2012's end, this may not be enough to deter investors from going into higher yielding and growing peers. Growth expectations are lower at Altria and Reynolds, but they both have significantly higher dividend yields and lower multiples. I would consider buying shares when the premium comes down.
Altria
Altria, for example, trades at a respective 16.6x and 15.2x past and forward earnings with a generous 4.6% dividend yield. The stock is also 60% less volatile than the broader market. Equipped with one of the strongest brands in consumer goods, the Marlboro-maker generates some of the highest returns in terms of ROA, ROE, and ROI.
During the second quarter, Altria beat expectations by 3.5% with EPS of $0.59. Adjusted diluted EPS was up 9.3% off of both strong gains in smokeable and smokeless segments but particularly in the SABMiller investment. Product innovation also remains a key selling point. The Marlboro EIGHTY-THREES packaging provide a very attractive way to address aggressive mandatory labeling procedures. I am also optimistic about the tobacco producer's promotional offerings for Marlboro green and black, which will help to secure sustainable free cash flow streams in the future. These decisions have already started to pay off with market share increasing to 42.9%.
Going forward, the company is committed to expanding market share while boosting margins. Management should address the smokeless segment where it does not have as great of a brand image and market position. U.S. Smokeless Tobacco Company, which is a subsidiary of Altria, produces Skoal and Copenhagen has grown retail share in the recent past, but Reynolds is facing headwinds against future growth in this area. I believe the company will nevertheless succeed off of its current momentum - 7.6% during the second quarter and a 10 bps market share gain.
Reynolds
The momentum at Reynolds in smokeless products is even better. The company grew retail share by 190 bps to 32.2% percent as Grizzly and Kodiak took off. EPS was still below analyst expectations, but market share by and large either stayed constant or grew. Promotion of Pall Mall as a cost-effective alternative appears to have paid off with 50% of first-time users continuing purchases. In the long-term, Reynold's large economic moat in snuff and chewing tobacco is a strong way to defend against regulatory headwinds in the cigarette market.
More importantly, Reynolds leads in terms of dividend distributions with a 5.1% yield. At 18.5x past earnings, the stock may appear expensive, but it should be mostly viewed as a stable income producer with forecasts for 6.6% annual EPS growth over the next five years. Should Reynolds just meet expectations, the 2016 stock price will be $57.39 at a 15x multiple. Discounting backwards by 8% yields a present value of $39. Accordingly, Reynolds looks overvalued at current prospects, but I believe investors will remain "glued" to the firm's leading dividend yield and diversification away from cigarettes.
Realizing the high valuation, Reynolds is rated a 2.9 out of 5 where "5" is a "sell" on the Street according to FINVIZ.com. ROA, ROE, and ROI are all below those of PMI and Altria, which suggests that much of Reynolds' value creation over the near-term will come from beating expectations especially during a challenging economy. PMI and Altria are not exactly cheap themselves, so investors will be much more willing to buy Reynolds should macro trends worsen. With poor job numbers and some economists anticipating continued sluggish progress, Reynolds is - all things considered - worthy of a slight investment.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.
