Although smoking seems old fashioned for many, big tobacco companies still seem poised to grow. Altria Group Inc (NYSE:MO), Philip Morris International Inc. (NYSE:PM) and British American Tobacco PLC (ADR) (NYSEMKT:BTI) offer compelling growth prospects, generating a buy consensus among analysts.
A company with a solid market position
With an industry-leading consensus annual growth rate of 11.23% expected over the next five years, Philip Morris International Inc. (NYSE:PM) stands as an interesting investment opportunity. Its scale (and resulting economies) combined with a strong position of its products in the market have provided the company with wider margins than its competitors, consistently delivering figures over 40%.
Although some of the firm’s traditional markets – mainly U.S. and the E.U.– are reducing their cigarette demand, the trend is the opposite elsewhere, especially in Asia, but also in
Eastern Europe, the Middle East and Africa, and this is where Philip Morris International Inc. (NYSE:PM) holds a dominant position. This puts Philip Morris in an advantaged position relative to its peers, including Altria Group Inc (NYSE:MO), which are usually less exposed to emerging markets.
Everyone knows how addictive cigarettes are, and that is great for Philip Morris International Inc. (NYSE:PM) as it provides it with a high pricing power. Holding the largest market share in an industry that is also characterized by lower swap rates between brands, profit is not an issue.
In 2012, about 37% of the firm’s operating income derived from the Asian market, particularly from Indonesia, China, the Philippines and Korea. However, the company still intends to expand in several other underpenetrated Asian markets with high population growth rates like India, Bangladesh and Vietnam, where further market share gains are expected. Of course, this expansion is backed up by a strong product portfolio that already competes in 180 countries and includes some of the most well-known brands in the world, like Marlboro, Parliament, L&M, Bond Street and Chesterfield, among others.
Despite regulatory and taxation threats, Philip Morris International Inc. (NYSE:PM) seems poised to grow and face any headwinds comfortably due to its diversified geographical base. With the best long-term prospects in the industry and attractive returns to shareholders through stock repurchases and a 3.58% dividend yield, I’d recommend
buying
this stock. Trading at 18 times earnings, just below the 18.1 average, this is a value stock, no doubt about it.
Another interesting pick
The situation for Altria Group Inc (NYSE:MO) doesn’t look as good as Philip Morris International Inc. (NYSE:PM), the company it spun off in 2008. However, it doesn’t look that bad either. On the one hand, its primary market, the U.S., has been offering a decreasing cigarette demand while regulation and tax levels become higher and stricter. On the other hand, it does hold about 50% of the U.S. market, which is, by the way, addicted to its product – and therefore less likely to stop consuming it.
This means that Altria Group Inc (NYSE:MO)’s future earnings will rely on its strong pricing power, since market expansion doesn´t appear to be an option. The market share also seems pretty set in the U.S. As the tobacco industry is characterized by low client migration and this is reinforced by growing marketing restrictions imposed by the government, the company’s market share will most likely remain unchanged, not rising but definitely not declining. Furthermore, Altria Group Inc (NYSE:MO) produces and sells Marlboro in the U.S., capturing a 42% of the market with no prospects of losing space to its competitors.
Moreover, Altria has entered the smokeless tobacco industry and captured almost half the market share. Unlike traditional tobacco, this segment is on the rise as migration from regular to smokeless tobacco increases. An incursion in the electronic-cigarette business was also announced a short time ago and will most likely contribute to the firm’s revenue in the upcoming years as demand for this product is also increasing. However, tobacco is not Altria Group Inc (NYSE:MO)´s only product. The company also offers a strong wine portfolio, which further strengthens its position.
So the question is: should you buy this stock? Well, the company’s management is efficient and has consistently reduced costs over the past years. This has resulted in more free money, many of which has been returned to shareholders, mainly through constantly increasing dividends that currently reach a 4.75% yield. Nevertheless, concerns about growth opportunities cannot be dismissed. Having said that, I would
buy and hold
this stock at 17 times earnings, as dividends paid every 90 days allow you to reinvest your money and widen future returns while earnings should continue to grow at an 8%-12% rate over the upcoming years. This could be the ideal retirement stock ; consider it.
A stock with increasing market share
Although British American Tobacco PLC (ADR) (NYSEMKT:BTI) does not sell a cigarette brand as strong as Marlboro, its products, comprising Dunhill, Kent, Pall Mall, and Lucky Strike, among others, have been increasing its market share over the past years. With almost three-quarters of its cigarette sales coming from developing markets, the company seems poised to grow as cigarette consumption per capita is projected to rise in these areas and customers are expected to migrate to premium cigarettes, which generate higher margins. Furthermore, the firm also holds a 42% stake in Reynolds American,
the second largest cigarette company in the U.S. after Altria, and a 31% share of ITC Limited, India’s leading cigarette enterprise. This further increases the exposure of the firm to these markets.
While the company faces the same threats as its peers, namely excise tax increases
and other regulations, its diversified product portfolio and international presence – principally in Europe, Latin America, the Middle East, and Asia – should help it remain profitable while maintaining its pricing power and high margins. In spite of trading at 23.3 times earnings – the industry median is 18 – I would still consider
buying this stock, especially as the company offers a
consensus annual growth rate estimate
of about 10% over the next five years. Moreover, its 5.04% dividend yield should continue to benefit stockholders; Morningstar analysts calculate that British American Tobacco PLC (ADR) (NYSEMKT:BTI) will continue to pay out about two thirds of its adjusted net income as dividends, providing a stable source of income for investors in the years to come.
Bottom line
Although tobacco could seem like a declining industry, this is only true for the more developed countries. Contrary to this belief, emerging markets have been, and promise to continue, increasing cigarette demand. These three companies offer compelling investment prospects for long-term (especially income) investors. Within the sector, I believe that Philip Morris, through its strong product portfolio and unmatched international presence, should outperform its peers and is, therefore, the best investment choice. Nevertheless, all of these companies should provide upside and a steady source of income for investors.
The article Should Big Tobacco Have a Place in Your Portfolio? originally appeared on Fool.com is written by Victor Selva.
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