By Matt Doiron
Cigarette companies are known for paying high yields, and Altria (NYSE:MO), formed from the breakup of cigarette giant Philip Morris to focus on the U.S. market, is no exception with a current dividend yield of 4.7%. Last quarter the company's revenue declined slightly compared to the first quarter of 2012, but thanks to cost cutting Altria's gross profits were up 21% with net income increasing at a slightly lower rate. While cash flow from operations was down a bit, the company still generated $1.8 billion in cash- easily enough to fund its dividend program and a small buyback and still swell its cash position by nearly a billion dollars during the quarter.
As with many cigarette companies, Altria has little exposure to the broader economy with a beta of 0.5. As such it should prove attractive to defensive-minded investors as well as to those who focus more exclusively on yield. In terms of fundamental value, however, we're a bit more concerned: the stock trades at 17 times trailing earnings, a pricing which we'd normally associate with moderate sustainable bottom-line growth. We've seen that Altria did well on that front in Q1, but we'd be concerned that over the long term the company won't be able to drive earnings growth entirely through margin increases. The earnings multiples aren't high enough to rule out Altria as an income stock, obviously, but we doubt that investors focused on pure value would find it as appealing.
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Other cigarette companies include Philip Morris International (NYSE:PM), Lorillard (NYSE:LO), Reynolds American (NYSE:RAI), and British American Tobacco (NYSEMKT:BTI). Lorillard and Reynolds American currently pay dividend yields of about 5%, slightly higher than Altria, and their stock prices have similar statistical relationships to market indices. Lorillard also deserves mention as carrying a discount to its peers, with a trailing P/E of 14; in addition, the company grew both its revenue and earnings in the first quarter of 2013 versus a year earlier. We'd be interested in learning more about the company. Reynolds American has been experiencing high earnings growth in percentage terms, but sales have actually been down and as with Altria we'd worry that this means the company will soon see net income numbers flatten out as well. The dividend yield is certainly high, but we aren't sure that Reynolds American is a better pick than Lorillard or Altria.
Yields are a bit lower at Philip Morris International and British American, but still strong on an absolute basis; both stocks are valued at 18 times their trailing earnings with Wall Street analysts expecting at least some growth in earnings per share over the next year and a half. Philip Morris' business has been about flat, which we suppose is at least as good news as the companies which have been growing their net income but doing so entirely through margin expansion. It turns out that British American is in that exact category: its numbers for the fourth quarter of 2012 show an earnings boost of over 50% compared to the same period in the previous year despite a small percentage decline in revenue. With that company's annual dividend yield and business performance being low relative to its peers, we would avoid it.