Lorillard More Undervalued Than These 2 Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With their high dividend yields and sustainable demand, tobacco stocks are relatively attractive for the "safety" they provide investors. However, this same attraction has led to many tobacco stocks becoming overvalued. In my view, investors should go for cheaper stocks like Lorillard (NYSE: LO), as opposed to more established tobacco producers like Philip Morris (NYSE: PM) and Altria (NYSE: MO).
Lorillard
At a respective 14.5x and 12.6x past and forward earnings, Lorillard is extremely cheap against peers. At the same time, its dividend yield of 5.3% is the highest in its industry. I believe that the market will make the dividend yield more in-line with the competition as greater buying activity follows. High double-digit ROA and ROI illustrate that the company is on a strong trajectory.
Analysts currently forecast 9.2% annual EPS growth over the next 5 years. Assuming the company meets expectations, 2016 EPS will come out to $12.22. At a 17x multiple, the future value of the stock would be $207.74. Discounting backwards by 8% yields a present value of $141.38. This figure is around a 20% premium to the current market value and justifies an investment. This is complemented by the fact that the stock is 58% less volatile than the broader market.
With the valuation currently around mid-way between the 52-week high and low, the timing for an entry looks right: there is neither a run on the stock nor a tremendous premium to local levels. While Marlboro may be more well-known than Newport, this has already been factored into the valuation given how low the multiples are on a relative basis.
Altria & Philip Morris
Both of these companies are marketers of Marlboro, the most famous cigarette brand in the world. Philip Morris was spun off from Altria a few years back in order for the parent company to target markets outside of the United States without being exposed to rising regulations. As well-run as these companies may be, I believe Lorillard will outperform.
Philip Morris has done an excellent job boosting free cash flow over the years - growing it to $9.6 billion in FY2011 from $7.2 billion in 2009. The company has a lot of room for penetration, and it has already delivered strong performance in a difficult environment. High profit margins and free cash flow, broad geographical diversification, and product innovation make the company a compelling a "buy.”
Even still, I believe the market has not reasonably factored in prolonged sluggishness of unit volume growth and an excise tax shock. I believe investors should buy Lorillard, which has gained the most volume of late. Altria, which targets domestic markets, has also recently reversed share losses. Trading roughly in-line with Reynold's, Altria is neither undervalued nor overvalued. While it is more expensive than the S&P 500 on a PE multiples basis, it deserves the premium due to its consistently impressive performance. However, in the long term, I believe those that are cheaper on a PE basis, like Lorillard, will catch up and reward shareholders for taking on the risk.
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