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Altria Group Inc (MO), Lorillard Inc. (LO), Reynolds American, Inc. (RAI): Why You Should Include These Tobacco Companies in Your Portfolio

Although many believe that tobacco is a declining industry, there is still potential in emerging countries. Despite having some room left for growth, I am particularly interested in the substantial dividend yields that some tobacco companies like Altria Group Inc (NYSE:MO)Lorillard Inc. (NYSE:LO), and Reynolds American, Inc. (NYSE:RAI) offer. Let’s take a closer look at them in order to understand if they stand as good investment opportunities for the long-term.

I love you Philip Morris

Altria Group Inc (NYSE:MO)

Altria Group Inc (NYSE:MO) (formerly Philip Morris) offers the highest dividend yield (4.99%) among the firms in this article. However, it is also expected to deliver the weakest EPS growth over the next five years. So, trading at 16 times its earnings, very close to the industry average, is this stock a buy?

On the bright side, Altria Group Inc (NYSE:MO) is the largest tobacco company in the U.S., holding about half the market share. Its strong brand portfolio that includes Marlboro, Virginia Slims, and Parliament among others, adds to the addictive nature of its products and has provided the firm with strong pricing power and a wide moat. This has helped the firm generate good amount of free cash flow and high returns on capital, which has in turn allowed it to return value to shareholders through dividend payouts. These dividends have been increased in almost every one of the last 45 years.

On the downside, Altria Group Inc (NYSE:MO) sold out its international segment and the majority of its non-tobacco assets, limiting its operations to the declining U.S. tobacco industry. However, holding an established, moated business with above average margins, while paying out juicy dividends, I’d recommend buying and holding on to this stock.

Finally, it is important to highlight that Altria Group Inc (NYSE:MO) has been diversifying its risks in the U.S. by adapting to evolving consumer demands; particularly, its incursion in the smokeless tobacco industry should increasingly contribute to revenue in the years to come.

Premium brands for premium margins

Lorillard Inc. (NYSE:LO) sits on the success of its premium cigarette segment. Actually, its main brand, Newport, holds about 40% of the premium cigarettes market share in the U.S. However, “with roughly 90% of its volume generated from the menthol category, and the threat of potential increased regulation from the U.S. Food and Drug Administration, the firm could be vulnerable to unfavorable regulatory developments.” (Morningstar)

In spite of this fact, analysts expect Lorillard Inc. (NYSE:LO) to deliver the highest EPS annual growth rates over the next five years, averaging 10%. In addition, the firm has been yielding 4.87% in the form of dividends. Going forward, this percentage is expected to rise to 5.03%. This shareholder reward policy depends on the company’s margin generation capabilities; mainly on account of the fact that most of its portfolio is composed of premium products, its operating margins are the highest in the industry.

Moreover, unlike most of its competitors, Lorillard Inc. (NYSE:LO) holds over 30% of the market share in two growth segments within the industry: menthol and electronic cigarettes. So, offering compelling growth prospects and a company moated by the addictiveness of its products, while paying out a juicy dividend and trading at 14 times its earnings, at about a 13% discount to the industry average, I’d recommend buying and holding on to this stock.

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