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British American Tobacco PLC (ADR) (BTI), Philip Morris International Inc. (PM): Emerging Tobacco Ideas

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BlackRock’s chief investment strategist believes that the market is starting to rotate out of typically defensive sectors and into more cyclical industries. To find a few investment ideas, I took a look at BlackRock Global Dividend Income Fund. While I was looking for cyclical names, I was surprised to come away with a list of tobacco companies.

Not What I Expected

Although BlackRock’s Russ Koesterich, the company’s chief investment strategist, believes that recent trends suggest a rotation away from consumer staples, the managers of Global Dividend Income Fund single out tobacco as fairly priced, but offering valuable exposure to emerging markets. That makes them interesting even if a rotation is in the cards.

In fact, emerging markets are likely to be a key source of industry growth. Smoking rates are relatively low in such markets and regulations are generally less stringent. With mature markets in slow decline, the industry is pushing hard to attract customers in these up-and-coming nations. Three tobacco companies worth taking a look at are:

Stable Business

Imperial Tobacco Group was among the fund’s top holdings at the end of March. The fund’s managers state that it “remains a conviction name due to the stability of the company’s business, attractive dividend yield and compelling valuation.” A recent yield of around 4.7% is clearly compelling. That said, there are some negatives here as well.

British American Tobacco PLCAlthough Imperial is one of the largest tobacco companies in the world, it isn’t exactly a leader. That said, it generates about half of its business from emerging markets. In addition, it has key positions in the cigar, fine-cut tobacco, and rolling paper markets. Back on the negative side, however, the other half of its revenues come from Europe. That slowly contracting business, though, is a cash cow that management is using to fund growth in emerging markets.

Debt made up about 60% of the company’s capital structure, which is a reasonable sum based on its business. Although the top line pulled back slightly in 2012, it has been growing steadily for years. That said, earnings and dividends have been far more variable. Although this is a “conviction” idea, I think two other fund holdings are better, though lower yielding, options.

The Global Brit

British American Tobacco PLC (ADR) (NYSEAMEX:BTI) is more of a global play on tobacco. The company has a big presence around the world, including earning “more than 50% of its revenue from emerging markets.” The rest of its revenues come from mature markets, including its roughly 40% stake in Reynolds American Tobacco. That means that it has more of a global footprint than Imperial.

That reach was highlighted in the company’s 2012 annual report when management reported that the company’s over 200 brands are sold in “around 180 markets.” This broad exposure to the world has helped revenues and earnings grow steadily over the last four years. The dividend, meanwhile, has been heading higher for over a decade. Debt makes up about half the capital structure.

A recent yield of around 2.5% isn’t too exciting, but performance at British American Tobacco PLC (ADR) (NYSEAMEX:BTI) has been more stable than that of Imperial. That’s particularly true of the dividend.

All of the Other Markets

Philip Morris International Inc. (NYSE:PM) is probably the best option of the three. The company was spun out of Altria, getting control of all of that company’s tobacco brands in international markets. Altria retained control of its brands in The United States. Part of the allure of Philip Morris is the stature of its brands, which include Marlboro.

Like British American Tobacco PLC (ADR) (NYSEAMEX:BTI), Philip Morris International Inc. (NYSE:PM) has two sides to its business, mature markets and emerging markets. Europe is a core market, though it is in slow decline. Emerging markets, meanwhile, are the growth engine and represented about three quarters of 2012 sales. So, it is among the best positioned companies in the emerging economies of the world. The company’s brands have a higher-end focus, too, which should become increasingly desirable as such nations industrialize and more people buy better quality cigarette brands.

A tax change in a key market has hampered results of late, however that should be a manageable long-term issue. Indeed, after years of reliable top line growth, 2013 might see a slight pullback. The dividend should continue its steady upward climb regardless of the top line. With a recent yield of around 3.5%, this industry giant offers a higher yield than British American Tobacco PLC (ADR) (NYSEAMEX:BTI), a better growth profile than Imperial, and a collection of truly iconic brands.

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