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Summary

  • Philip Morris and British American Tobacco increased earnings last year, but Philip Morris has the better prospects.
  • Although British American Tobacco has a higher yield, we think there is more scope for dividend increases at Philip Morris.
  • We feel that Philip Morris' current discount versus British American Tobacco is unwarranted and, as such, its shares could outperform on a relative basis.

We thought it would be interesting to see how Philip Morris (NYSE:PM) compares to a major international rival. Indeed, another member of the group of the biggest four tobacco firms in the world by sales, British American Tobacco (NYSEMKT:BTI) seems to fit the profile perfectly, since it is of a similar size to Philip Morris, with the two companies having market caps of $132 billion (Philip Morris) and $113 billion (British American Tobacco). We hope you enjoy the article and follow us/comment afterwards!

Declining Sales

As with all tobacco companies, declining cigarette sales are continuing to be a problem for Philip Morris and for British American Tobacco. Indeed, a glance at the two companies' quarterly results confirms this, with Philip Morris seeing sales fall by 1.5% and British American Tobacco's top line declining by 0.6%. This situation looks set to continue in the short term as the twin issues of counterfeiting and an embracing of new technology via e-cigarettes starts to take hold.

Increasing Profits

Of course, the great thing about being a tobacco company is that the product you are selling is highly price-inelastic. This means that demand for the product does not change much, even when there is a large change in price. Clearly, for tobacco, this is the case because it is addictive and is the reason why, despite volumes coming under pressure, British American Tobacco was able to increase EPS (at constant currency) by 10% in 2013. Likewise, Philip Morris grew its EPS by 10% in 2013, as both companies were able to make cost savings to their manufacturing processes and supply chains, in addition to increases in sales prices per pack of cigarettes.

Future Potential

Going forward, the potential for Philip Morris and British American Tobacco continues to lie with increasing prices, as well as developments surrounding their e-cigarette technology. For instance, British American Tobacco has launched an e-cigarette brand, Vype, which is well-positioned to gain market share of what is now a $1 billion industry. Meanwhile, Philip Morris plans on entering the e-cigarette market later on in 2014 with its launch of the Marlboro e-cigarette in Italy. However, it appears as though Philip Morris was slow to get out of the blocks, as British American Tobacco has had its product at market for over one year already. This, though, is not set to slow down Philip Morris' growth rate, as the company is forecast to increase EPS by 8.5% next year, while its UK-listed rival is due to deliver flat earnings next year.

Yields

While the yield on the S&P 500 has slipped below 2% in recent months, Philip Morris and British American Tobacco continue to offer strong yields. Indeed, Philip Morris has a forward yield of 4.1%, while British American Tobacco's yield is 5.4%. However, we feel there is more scope for dividend increases at Philip Morris, since its payout ratio is lower than that of British American Tobacco (72% versus 76%) and its earnings growth profile is stronger, as previously mentioned. Therefore, while both stocks have great yields, we feel that Philip Morris could have the most potential on this front going forward.

Valuation

We're slightly surprised to see that Philip Morris trades at a discount to British American Tobacco in terms of the P/E ratio (TTM), with the former having a P/E ratio of 16.4 and the latter's P/E being 17.5. That's because Philip Morris has the stronger growth prospects over the next year (as discussed earlier), so we feel that it should merit a premium rather than a discount, compared to its peer. As a result, we believe that Philip Morris could outperform British American Tobacco going forward.

Conclusion

Both Philip Morris and British American Tobacco have experienced challenging recent quarters; however, due to their increased pricing and cost savings, they were able to post 10% increases in EPS last year. However, going forward, Philip Morris appears to have the superior growth prospects, with its EPS forecast to grow by 8.5% next year, while British American Tobacco's is expected to flat-line. Furthermore, Philip Morris could gain an uplift from the launch of Marlboro e-cigarettes, while British American Tobacco has already had its product at market for over a year.

Sure, British American Tobacco pays a higher yield right now, but we think there is more scope for Philip Morris to increase its dividends due to the higher earnings growth rate and lower payout ratio. As a result of a lower valuation versus British American Tobacco, we think that Philip Morris could outperform its peer going forward as the market adjusts to a relative mispricing.

Please follow Team Money Research for more updates on Philip Morris and its peers!

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: Philip Morris Could Outperform This Sector Peer