Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Altria Group Inc (MO), Reynolds American, Inc. (RAI), Philip Morris International Inc. (PM): There Is Trouble Brewing at Two Defensive Tobacco Companies

After a record first half, tobacco stocks are now starting to pull back as the high-yield sector of the market is sold-off. During the first six and a half months of the year, Altria Group Inc (NYSE:MO) matched the S&P 500 with gains of 17.5%, while Reynolds American, Inc. (NYSE:RAI) climbed 24% and Philip Morris International Inc. (NYSE:PM) advanced 7.3%, all excluding dividends (the S&P 500 gained 18% over the same period). However, since the recent sell-off began, all three companies have wiped out most of their gains so far this year.

Altria Group Inc

So is it time to take a position?

It could be, although there are several factors weighing on these companies that I am concerned about–and I’m not talking about the fact that they sell tobacco.

Rising debt, falling equity

Tobacco companies have been buying back shares in an attempt to offset declining sales and earnings. In particular, Philip Morris International Inc. (NYSE:PM) has been buying back huge quantities of stock, but this is at the expense of shareholder equity; the company has borrowed heavily to finance these buybacks.




Q1 2013

Q2 2013

Cash Flow from operations





Buybacks and Dividends





Figures in $ billions

Simply put, Philip Morris International Inc. (NYSE:PM) is spending more than it can afford on dividends and buybacks. During 2012, the company spent $2.6 billion more on investor returns than cash flow from operations provided, and the same can be seen for the first quarter of this year.










Long-term debt









Fully diluted number of shares …









Book Value per Share









Figures in millions

Applying this to long-term debt forecasts and the number of shares in issue, an astonishing trend appears. The company’s book value per share will be-$6.71 by the end of 2015; considering the company has already committed to its buyback plan up to this point, this is almost a certainty.

Philip Morris International Inc. (NYSE:PM)’ liabilities are far exceeding assets and total equity has rapidly declined. Now, I’m not saying that Philip Morris’ debt is unsustainable; in fact, it is quite the opposite. Interest costs were covered 12x by EBIT during the first quarter of this year, and debt to EBITDA was only 1.2x at the end of 2012. However, what is concerning is that after Philip Morris has finished spending, what will happen to the debt? The company cannot continue spending indefinitely. It will need to pay down debt, and this will mean a reduction in shareholder returns.  


In comparison, Altria Group Inc (NYSE:MO), which is all around more diversified and financially prudent than Philip Morris International Inc. (NYSE:PM), has a much stronger balance sheet with stable net debt, positive shareholder equity and a positive book value per share.










Total equity









Net debt









Fully diluted number of shares …









Book Value per Share









Figures in $ except for number of shares

The lower amount of debt gives Altria Group Inc (NYSE:MO) a much better-looking balance sheet with more financial headroom for sudden surprises or growth through acquisitions. Of course, this will mean slower EPS growth for Altria’s investors. Indeed, Altria’s EPS growth over the past five years has been 7% compared to Philip Morris’ 12%. However, Altria’s outlook is more stable; the financial headroom gives the company space to generate cash, raise finance for acquisitions and return more to investors via a dividend. In addition, Altria is significantly more diversified than Philip Morris, and for this reason the company should be around longer than its international peer.

Shareholder equity

In fact, Altria Group Inc (NYSE:MO) is the only big US-listed tobacco company that has positive shareholder equity. Well, actually, Reynolds American, Inc. (NYSE:RAI) also has positive shareholder equity, but the majority of this is goodwill.

Reynolds’ balance sheet


Q2 2013



Trade debtors




Net debt




Total assets


Total equity


Total assets ex. goodwill


Total equity ex. goodwill


*Figures in millions

Goodwill is an intangible asset and it is often considered to be more of a liability. Certainly any company with a large amount of goodwill on its balance sheet should be carefully scrutinized as accounting standards, write-downs and revaluations can quickly adjust goodwill. Adjust Reynolds American, Inc. (NYSE:RAI)’ balance sheet to remove the goodwill and the company has a total equity value of -$2.9 billion.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.