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Summary

  • This article discusses why Altria offers a better alpha opportunity than sector peers Philip Morris and Reynolds.
  • It focuses on the relative strengths and weaknesses of Altria versus its two rivals based on business performance, sustainability/dividends and value.
  • It concludes by detailing the alpha opportunity that we feel is on offer at Altria.

In this latest installment of our Alpha Opportunities series, we discuss why Altria (NYSE:MO) is a better buy than Philip Morris (NYSE:PM) and Reynolds (NYSE:RAI). Don't forget to let us know what you think once you've finished reading!

Altria Background

Altria Group, Inc. was founded in 1919 and is headquartered in Richmond, Virginia. It manufactures and sells cigarettes, smokeless products, and wine in the United States and internationally. It offers cigarettes primarily under the Marlboro brand; cigars principally under the Black & Mild brand; and smokeless tobacco products under the Copenhagen, Skoal, Red Seal, Husky, and Marlboro Snus brand names. The company also produces and sells blended table wines under the Chateau Ste. Michelle, Columbia Crest, and 14 Hands names.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We score each company relative to its peers on the following criteria within each of our 2 main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends

  1. Debt-to-equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Yield
  5. 5 year average yield

Once we have scores for the 2 buckets, we can then assess whether there is an alpha opportunity available given the current valuations of the 3 stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Price-to-earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price-to-sales ratio
  5. 5 year price to earnings growth ratio

So, for example, a company that scores well relative to its peers on the first two buckets (business performance and sustainability/dividends) and that is undervalued relative to its peers (based on the third bucket: valuation) would be considered an alpha opportunity. In such a case, we would generate a target price for the alpha opportunity that is prudent relative to the valuations of its peers.

The table below highlights the data that we will use to score Philip Morris, Altria and Reynolds on a relative basis for the first two buckets.

Stock

Philip Morris

Altria

Reynolds

Business Performance

Return on equity

N/A - negative equity

111.58%

30.56%

Return on assets

22.78%

13.90%

11.63%

Operating margins

43.88%

44.88%

36.57%

Quarterly rev. growth

-8.80%

0.90%

2.80%

Quarterly EPS growth

-11.80%

-15.20%

-28.50%

Sustainability/Dividends

Debt to equity ratio

N/A - negative equity

337.40%

101.64%

Interest cover

11.01

12.80

10.00

Dividend payout ratio

72.00%

87.00%

89.00%

Dividend yield

4.10%

4.50%

4.30%

5 year average yield

4.30%

5.80%

5.80%

We then rank each company relative to its peers based on the above data, with scores being awarded as follows:

1st place relative to peers: 10 points

2nd place relative to peers: 5 points

3rd place relative to peers: 0 points

Below are the scores for Philip Morris, Altria and Reynolds:

Stock

Philip Morris

Altria

Reynolds

Business Performance

Return on equity

0

10

5

Return on assets

10

5

0

Operating margins

5

10

0

Quarterly rev. growth

0

5

10

Quarterly EPS growth

10

5

0

Sustainability/Dividends

Debt to equity ratio

0

5

10

Interest cover

5

10

0

Dividend payout ratio

10

5

0

Dividend yield

0

10

5

5 year average yield

0

7.5

7.5

Total Score

40

72.5

37.5

As you can see, Altria scored the highest relative to its two peers. Indeed, it was no worse than second place in any of the 10 criteria, which highlights how consistent the company is on a relative basis. We were particularly impressed with Altria's operating margins and return on equity, although it should be noted that the latter figure is aided through Altria being funded by a low amount of equity. As for sustainability, a strong interest coverage ratio and great dividend yield are further plus points for investors in the stock.

Meanwhile, Philip Morris and Reynolds were almost tied for second place, with Philip Morris' relatively low payout ratio helping it to edge out Reynolds. Philip Morris, of course, suffered from having negative equity, which meant it scored zero for the return on equity and debt to equity criteria, although it scored reasonably well in terms of interest cover and payout ratio, so looks to be relatively sustainable.

Reynolds posted surprisingly strong revenue growth last quarter of 2.8%, which was ahead of its two peers. It also has impressive return on equity and has the lowest debt-to-equity ratio, which highlights that, although it came in third place, it remains sensibly funded and highly profitable.

Alpha Opportunity?

So, we feel that Altria is a higher quality stock than its two main rivals, Philip Morris and Reynolds. Therefore, we believe it should trade at a premium to its two rivals. Let's see whether it does.

Stock

Philip Morris

Altria

Reynolds

Valuation

Price to earnings ratio

15.48

15.53

16.93

Price to book ratio

N/A - negative equity

20.57

6.58

EV/EBITDA

11.39

11.60

11.65

PEG

2.46

2.24

2.48

Price to sales ratio

4.43

4.78

3.98

As well as being the highest quality company, Altria also appears to offer good value on a relative basis. For example, its P/E and EV/EBITDA ratios are only the second highest of the three stocks, while its PEG ratio is the lowest. Due to its comfortable victory in the first two buckets (business performance and sustainability/dividends) and its relative value, we believe there is an alpha opportunity going long on Altria.

Target Price

With a strong showing in the business performance and sustainability/dividends buckets, we feel that Altria deserves to trade at a premium to Philip Morris and Reynolds. As such, a P/E ratio of 18.62 seems appropriate (10% higher than the P/E ratio of Reynolds), given Altria's strong performance in the business performance and sustainability/dividend buckets.

This generates a target price of $51.26, which is 19.9% higher than the current share price of $42.75.

Conclusion

Altria is a great company that we believe offers the opportunity to generate alpha. It scored highly on the Team Money Research rating system, beating its two main rivals. It also appears to be undervalued at current levels and, as such, could be a strong performer over the medium term.

Stock

Altria

Team Money Research View

Buy

Team Money Research Target Price

$51.26

What do you think of Altria, Philip Morris and Reynolds? Please share your views below…

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

Source: Why Altria Easily Beats Philip Morris And Reynolds