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Altria (MO) is seen as a stable company providing good dividend yields but with fewer growth opportunities, particularly compared to its international brother, Philip Morris (PM). But the company has proven that it can find good growth opportunities within the domestic market, some of them, like Altria's 30% stake in global brewing giant SABMiller (SAB), even unrelated to tobacco. While the cigarette industry is estimated to decline continuously over the next few years, Altria is expected to see over 5% earnings growth in 2013. This is driven by a diverse product mix and the result of an extensive cost savings program. Can Altria beat a tobacco market that is expected to decline?

Altria is the U.S. leader in cigarette sales market share at 50%, with Reynolds American (RAI) coming in second around 30%. Reynolds has seen its revenue decline by almost 4% so far this year. The company is managing to keep profits in line due to raising prices, but the lower sales volume has to be troubling. Altria is seeing revenue growth while also seeing solid earnings.

The third biggest player in the U.S. cigarette industry is Lorillard (LO), with around 10% of the market. Lorillard has shown good revenue and earnings growth over the year. The driving force behind Lorillard's growth comes from its most popular Newport brand of menthol cigarettes. The problem here is that the FDA has already voted to ban menthol cigarettes and that should keep investors leery of this stock. If that ban came to fruition it would have a huge negative impact on Lorillard.

British American Tobacco (BTI) is seeing pressure from international markets, including slowing demand from Italy, Turkey, Egypt, Japan and Brazil. The decline in these countries overpowered the modest volume growth in Russia and Asia. British American was powered by its Lucky Strike brand in the first half of the year, with volume up 19%. The company is also expected to grow EPS 8% this year despite its exposure to a weak European economy. I believe that even though the company is expected to have positive growth next year it still trades too rich on a valuation basis.

The tobacco companies appear to trade in a tight range on a P/E and P/S basis, with British American being the clear outlier, trading above its peers.

 

P/E

P/S

Dividend Yield (%)

Altria

17

3.8

5.3

Reynolds

17

2.9

5.5

Lorillard

15

3.4

3.5

Philip Morris

18

4.8

3.8

British American

20

4.1

2.6

Even though the U.S. cigarette market has been in decline since 2009, Altria's acquisition of the smokeless tobacco company UST gives it another competitive advantage. Around 73% of Altria's sales come from cigarettes, but strong sales of smokeless tobacco are impressive. Smokeless tobacco accounted for around 10% of sales and has been growing 3.5 to 4% yearly. Copenhagen and Skoal are now 15% of sales. Cigarette use has declined 1.2% to 2.4% since 2009, but Altria's other brands are making up for this loss. EPS this year is earmarked for $2.21, versus the projected $1.64. Smokeless products also offer higher margins for the company. The company is focused on expanding its product mix to help mitigate the constant litigation that the tobacco industry faces, and I believe Altria is better positioned to do so relative to its peers in large part because of its diverse smokeless product line.

Altria is well positioned to increase its market share in this fast growing segment, and I expect the size of smokeless products to grow at an annual rate of 7% over the next few years. Of the tobacco stocks, Altria is in the leading diversified company. It will dominate the smokeless market far into the foreseeable future with its profitable smokeless tobacco sales. It has delivered solid dividends and seems to be on track for sales other than cigarettes. This is a wise plan. I believe Altria's revenue will be around $23 or $24 billion in 2013 and 2014, barring interest rates rising much. I recommend buying Altria at the current price and see it as a better value currently than the other tobacco stocks.

Source: Altria: Smokeless Tobacco Will Spur Healthy Gains In 2013