If I told you that I know a company with a 5% yield and that analysts expect EPS growth of about 9.6%, would you be interested? How about if I also told you that this same stock sells for a forward P/E of under 14? Now, let’s see if you are still interested when I give you the name: Lorillard Inc. (NYSE:LO). That’s about what I thought, of those who read the last sentence, I’m thinking only about 50% are still reading. The cold hard fact is, certain investors simply won’t consider investing in a company in the tobacco industry. That being said, the investment case for Lorillard is very simple, you get a great yield and earnings growth for a very reasonable value.
Let’s Get Right Down to It
Let me say up front that I understand the hesitation to invest in a tobacco company. However, if you have no such reservation, these companies offer some very compelling values. For instance, what other industry offers multiple companies with yields of around 4% to 5%, in addition to earnings growth of between 7% and 11%? When you combine these impressive numbers with reasonable P/E ratios, you could have a winning combination.
In fact, I would argue one of the best reasons for investors to consider Lorillard has to do with these very three metrics. Lorillard currently offers a yield of about 5%, and compared to its competition only Reynolds American, Inc. (NYSE:RAI) offers a higher yield at roughly 5.2%. Whereas some investors might choose Altria Group Inc (NYSE:MO) and its 4.8% yield, the comparison gets a little more difficult looking at Philip Morris International Inc. (NYSE:PM) and its 3.7% yield.
If we look at each of these company’s growth rates, Philip Morris is expected to grow the fastest at 11.23% over the next few years. Lorillard comes in a respectable second place with an expected growth rate of about 9.6%. Reynolds American and Altria, on the other hand, are both expected to grow earnings at a slower pace closer to 7.5%.
When you realize that Lorillard Inc. (NYSE:LO) has the second best yield, and the second best growth rate, you might be surprised to find that the stock actually sells for the lowest forward P/E ratio. At just less than 14 times projected earnings, Lorillard is priced lower than the slower growing Reynolds American or Altria, which both sell for P/E ratios of over 15. While Philip Morris is expected to grow faster, its share value reflects this with a P/E ratio of about 16.4. As you can see, with the lowest valuation and the second best yield and growth, it seems investors are getting a lot of bang for their buck.
Organic Growth and the Future of Cigarettes
In the tobacco industry, one of the most difficult things is for companies to show real revenue growth. In fact, of the four companies we’ve looked at, only Philip Morris and Lorillard Inc. (NYSE:LO) saw positive revenue growth in the last quarter. What’s particularly interesting, Lorillard doesn’t have the same growth profile as the internationally focused Philip Morris, yet the company reported revenue growth of 3.3%, which beat Philip Morris’ growth of 3.2%. With both Reynolds American and Altria reporting revenue declines of at least 2%, you can see that top-line growth is tough to come by.