What's In Store For This Tobacco Master?

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Reynolds American (NYSE: RAI) is the second largest tobacco company in the United States. Its subsidiaries include American Snuff, R.J. Reynolds Tobacco, Niconovum AB and Santa Fe Natural Tobacco.

Reynolds American Earnings

Recently, Reynolds American announced its earnings for 4Q12. According to the company, its earnings were down to $0.25 per share or $139 million from 4Q11’s earnings of $304 million or $0.52 per share. Revenues (excluding excise taxes) for the fourth quarter stood at $2.08 billion.

The total number of cigarettes sold by R.J. Reynolds Tobacco was down 3% to 17.1 billion. Pall Mall’s grew by 5.5%, while Camel’s volume dropped slightly. Pall Mall’s market share was up 0.3% whereas Camel’s market share remained at 8.6%. In case of Santa Fe Natural Tobacco, sales for its Natural American Spirit were up 20% to 800 million cigarettes.

In order to get into the smokeless market, Reynolds American bought Niconovum AB about four years ago. Talking about the smokeless business, Reynolds American grew 7% as compared to the last year. Currently, company’s smokeless brands have a 32.6% market share in the United States. According to the company, its recent nicotine gum is getting a healthy feedback from its test market in the United States.

As far as 1Q13 is concerned, the company expects earnings per share of $0.68 on revenues of 1.9 billion.

Valuation

Reynolds American is currently trading at a forward P/E (1yr) of 13.08x and has a dividend yield of 5.30%. It has a PEG of 2.06, adding its dividend into this gives us a PEGY of 1.27. Using an average forward P/E of 13.63x for the tobacco industry, we can value Reynolds American.

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As the cigarette industry isn’t expected to generate significant profits in the coming years, we would value Reynolds using low consensus estimates. Using low consensus estimates, its value comes out to be $43.62; showing that it’s trading at its fair value. That's why, it’s not an attractive buy at this moment.

Tobacco industry

On the February 13, the U.S. cigarette manufacturer, Lorillard (NYSE: LO) released its earnings for 4Q12. Revenues for the quarter were up 5% amid more prices and shipments, while the number of cigarettes sold grew 2.9% to 1.67 billion. The company has recently announced to increase its dividend by 6.5% to $0.55 per share. Currently, Lorillard is trading at a forward P/E (1yr) of 13.65x and has a PEG of 1.66; incorporating its dividend yield in this gives us a healthy PEGY of 1.05. Plus, a mean recommendation of 2.3 on the sell side shows that it’s one of the best buys in the tobacco industry.

The American tobacco and cigarette company, Philip Morris International (NYSE: PM), is trading at a forward P/E (1yr) of 14.22x and has a dividend yield of 3.80%. It has a strong PEG of 2.2 and a PEGY of 1.08. A mean recommendation of 2.2 on the sell side shows that it’s a far better buy than Reynolds American. A mean target price of $96.79 on the sell side shows that it has an upside potential of 6.5%. Hence, just like Lorillard, it’s one of the top buys in the tobacco industry at this point in time.

Conclusion

High cigarette taxes, smoking bans, and weak economy are the major reasons behind the sluggish cigarette industry. Further, more competition in the industry means that the profits would be shared in the future. As a result, most of the cigarette manufacturers are moving towards the smokeless market in the tobacco industry. Therefore, investing in products such as chewing tobacco and snuff has become the latest norm. However, Reynolds American is still far away from capturing substantial market share in the United States’ smokeless market. Moreover, with tough competition in the market, things won’t get much better in the near future. As a result, we remain neutral on Reynolds American.


Vamosrafa7 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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