Reynolds American Is Not A Buy Despite A High Dividend Yield Of 5.3%

| About: Reynolds American, (RAI)

Reynolds American (NYSE:RAI) has delivered healthy financial performances in the past; however at current valuations (forward P/E of 13.2x and PEG of 1.9) the stock is slightly overvalued. Also, I believe Lorillard (NYSE:LO) offers better investment opportunity than RAI as LO has cheap forward P/E of 12.1x and has a lower PEG of 1.5 than RAI. Also, LO offers an attractive dividend yield of 5.3%. Here is my recent analysis on LO.

RAI has delivered satisfactory financial performance for the recent year 2012 and 4Q'12. Following are the financial highlights of the full-year 2012 and recent fourth quarter.

Full Year 2012
RAI reported net sales of $8.3 billion, compared with $8.5 billion in 2011. RAI's net sales for the year declined due to health concerns and ongoing anti smoking campaigns, which are resulting in lower sales volume. Total cigarette volumes declined by 5.6% for the company compared with a 2.3% decline for the tobacco industry in 2012.

Full-year 2012, adjusted EPS for RAI came out to be $2.97, up 5.7% year on year, beating consensus by 3 cents. Adjusted operating income for the year was up 1.6% to 2.86 billion. The following charts show revenue and operating income contributions by different reporting segments of RAI for 2012.

Source: Company Report and Calculations

Fourth Quarter 2012
Intense competition, rising regulations, and an anti smoking campaign in the U.S. adversely impacted RAI's net sales for the most recent quarter and hence they were down by 0.25%, year-over-year, to $2.08 billion. Cigarette volumes for the company were down 2.7% in the recent fourth quarter in contrast to 0.8% volume decline for the industry.

Despite a competitive business environment in the industry, RAI was able to grow its adjusted EPS by 5.6% to 76 cents in 4Q'12. It was also able to beat earnings consensus by 4.1% in the recent quarter. Selling, general and administration expenses were up by 30% in the fourth quarter, mainly due to higher promotional spending.

RJ Reynolds is the largest segment of the company in terms of net sales and earnings contribution. The segment's net sales were down by 2.5% to $1.72 billion in the recent fourth quarter. Adjusted operating income for the segment also declined by 4.5% to $570 million for the quarter. RJ Reynolds' retail market share was down to 26.4% in the quarter compared with 27.3% in 4Q'11.

American Snuff, the second-largest segment of the company in terms on sales and earnings, experienced net sales growth of more than 7% in the recent fourth quarter. Volumes for the segment were up by 7.2% in 4Q'12. Volume growth for the segment positively impacted the adjusted operating earnings for the segment, which were up by 10%.

Share buyback and Dividend
The company repurchased $250 million worth of common stocks in fourth-quarter 2012, under its ongoing share repurchase program of $2.5 billion. RAI share repurchase spending stood at $1.1 billion in 2012.

Furthermore, other than sharing its profit in the shape of share repurchases, the company also offers a high dividend yield of 5.3%. RAI has increased its annual dividend from $1.70 per share in 2008 to $2.36 per share in 2013. The following table shows annual dividends offered by the company since 2008.

RAI provided 2013 earnings per share guidance range of $3.15-$3.30. In contrast analysts are expecting $3.2 per share for the company in 2013. Also, analysts are anticipating the next five years' growth rate of 7.3% per annum.

RAI has delivered healthy performance in the past and also is expected to grow at a decent rate of 7.3% for the next five years. However, I believe at current valuations RAI is slightly overvalued. Also, I believe Lorillard offers a better investment opportunity than RAI, as LO has cheaper forward P/E of 12.1x and lower PEG of 1.5 (lower PEG for LO reflects cheaper growth) compared with its peers.

Dividend Yield

Forward P/E










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Source: Yahoo finance

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.