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Reynolds American, Inc. (RAI), Altria Group Inc (MO): A Look at Cigarette Companies in a Declining Market

Trading at a 12% discount to industry average valuations and offering almost a 5% dividend yield, the stock is attractive. On the downside, debt has risen exponentially while cash volumes remain stagnant. Also, EBITDA for the firm is half that of Reynolds’, and insider sales have been plenty. Last, the business marketing strategy has not been successful when compared to major competitors.

In all, Lorillard Inc. (NYSE:LO) is not a good option for long-term investment, and it is recommended to hold. The company has entered the smokeless business, but acquisitions alone do not guarantee future profits. It is necessary for the company to develop new products and inaugurate an R&D division with that purpose.

The cowboy will kill you

Leading the cigarettes market, Altria Group Inc (NYSE:MO) holds the biggest potential for losing in the future. Holding a staggering 50% of the cigarette market, future FDA regulations and taxation hold the potential to gravely hurt revenues and income. Also, the company is currently in no better position than Lorillard Inc. (NYSE:LO).

Raising prices can delay negative revenue effects, derived from government regulation and market declining volumes. Altria Group Inc (NYSE:MO) holds an important pricing leverage, but price marking may drive customers to switch brands, especially if the company is curtailed from communicating discounts due to tough advertisement regulation.

When looking at finances, Altria Group Inc (NYSE:MO) has put free cash flow back into a positive trend. However, overall cash has not recovered since 2008 and debt levels have passed historic highs. In consequence, the firm holds a comparative less potential for R&D and adaptation to new market trends.

Finally, Altria Group Inc (NYSE:MO) is trading at a similar premium than Reynolds, but holding a greater operating margin. It is recommended to hold because the firm continues to trust on its leading market position, and has not taken decisive steps to meet new market trends.

Adapt quickly or take your winnings

Current times are not good for freshman smokers. Government regulation and health awareness have put the focus on the downside of smoking. However, the change on market trends brought new opportunities for those willing to adapt. It is my opinion that Reynolds has done the most to adapt so far, and for that simple reason holds the best potential for future revenues. The company is in the best position to steal customers from those competitors still focused on making profits from cigarettes.

Damian Illia has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
Damian is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article A Look at Cigarette Companies in a Declining Market originally appeared on is written by Damian Illia.

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