Philip Morris: The Best Value In Tobacco Stocks

Includes: BTI, LO, MO, PM, RAI
by: Bill Maurer

We all know that tobacco companies pay nice dividends and are safe value plays. I'm not endorsing smoking here, and to be fair, I did once participate in a Socially Responsible Investing Company.

I'm not here to debate the morals of smoking or say that you should or shouldn't buy any of these stocks. All I'm going to do is analyze them and provide a recommendation on which excel in certain metrics. What you choose to do is up to you, and I am not trying to influence that in any way. So let's get down to business. We all know about Altria (NYSE:MO) and Philip Morris (NYSE:PM), but I will also take a look at Reynolds American (NYSE:RAI), British American (BAT), and Lorillard (NYSE:LO).

Current Price $27.17 $69.62 $107.08 $38.08 $92.40
52-week high $28.14 $72.74 $120.00 $39.94 $96.00
52-week low $23.20 $55.85 $72.40 $30.94 $72.54
Market Cap. $55.81B $121.77B $14.46B $22.20B $91.54B
Dividend Yield 6.04% 4.42% 4.86% 5.57% 2.56%
1-Year Return 12.79% 21.93% 27.46% 22.25% 24.26%
5-Year Return 95.19% N/A N/A 63.15% 109.38%
Since PM IPO 59.26% 65.37% N/A 61.63% 42.35%
Since LO IPO 62.60% 65.05% 67.03% 80.73% 47.49%
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PM shares have only traded since 3/17/2008; LO shares since 6/10/2008.

Most of these stocks are near 52-week highs, although Wednesday's market drop did take a chunk out of these names. Altria always has and probably always will have the highest dividend yield, but not always the best price appreciation. You can see that over the past year. In rising markets, it's not a good play. In declining or mixed ones, it provides a nice amount of safety.

Altria is the domestic side of the business, while Philip Morris is the international side. Philip Morris is the largest of the five by market cap. Lorillard has done the best over the past year. Reynolds American has done the best since the Lorillard IPO, and British American has done the best over the past 5 years. All of the performance numbers above are adjusted for any dividends and splits. Let's get to some real numbers, though.

Revs (2010) $16.89B $27.21B $4.05B $8.55B $23.01B
Revs (2011 est.) $16.93B $30.51B $4.24B $8.59B $23.83B
Revs (2012 est.) $17.22B $31.31B $4.50B $8.73B $25.34B
EPS (2010) $1.90 $3.87 $6.78 $2.49 $5.43
EPS (2011 est.) $2.04 $4.82 $7.65 $2.64 $6.00
EPS (2012 est.) $2.19 $5.19 $8.54 $2.81 $6.77
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All five names are expected to grow revenues and EPS during 2011 and 2012. Altria and Reynolds expect slow revenue growth in 2011 and accelerated growth in 2012. Philip Morris sees more growth in 2012. Lorillard and British American see a fair balance between the two years. Philip Morris has the best two year EPS growth at 34%, but most of that is in 2011. Lorillard and British American expect growth in the mid 20s, with almost equal growth in each year. Altria and Reynolds also are expected to have similar percentage growth in the two years, but the total growth for both is under 16%. Based on this analysis, Philip Morris is your best bet with Lorillard second, British American third, Reynolds fourth, and Altria last.

Margins (ttm) MO PM LO RAI BTI
Gross Margin 53.90% 65.58% 51.59% 46.94% 76.74%
Operating Margin 39.63% 43.42% 43.97% 29.48% 35.15%
Net Margin 21.16% 27.76% 24.49% 15.61% 21.46%
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Getting those growing revenues into growing profits is not always easy, but Philip Morris does it the best. The company boasts the highest net margin and is second in the other two metrics. Lorillard has the second highest net and the highest operating, but the second lowest gross. Reynolds has the lowest in all three categories. British American and Altria fight for third, and depending on which margin number you favor, you might like one over the other. I would go with British, because it has the highest gross and a better net. But you may choose otherwise.

Valuations MO PM LO RAI BTI
P/E (2011 est. EPS) 13.32 14.44 14.00 14.42 15.40
P/E (2012 est. EPS) 12.41 13.41 12.54 13.55 13.65
Price/Sales (ttm) 3.46 4.09 3.41 2.65 3.91
PEG (5-year) 1.68 1.13 1.51 2.44 1.40
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Altria has the lowest P/E numbers, but is third in the other two areas. British American has the highest P/E numbers, a high price to sales, but a fair PEG ratio. Philip Morris has the highest price to sales, but the lowest PEG. So which metric do you prefer. I like P/E numbers first, then PEG ratios second. Remember, you have to take the revenue and earnings growth numbers from above into consideration when looking at valuations.

I'm more than comfortable choosing Philip Morris here because it has the highest expected growth of the bunch. Thus, I'm willing to pay an extra half point or so on the P/E multiple. Altria may be the cheapest, but offers the lowest growth. Lorillard is my #2 in this area.

Financials (mrq) MO PM LO RAI BTI
Current Ratio 0.94 0.97 1.92 1.09 1.01
Debt Ratio 88.03% 86.76% 137.25% 59.07% 67.49%
Working Capital ($404M) ($430M) $1.3B $359M $102M
Cash $3.04B $2.18B $1.7B $2.01B $2.75B
Short Term Debt $600M $3.88B None $460M $3.69B
Long Term Debt $13.09B $13.04B $2.59B $3.21B $13.95B
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BTI as of 6/30/11; all others as of 9/30. BTI data based on exchange rate of .624472 pounds to the dollar on June 30.

Reynolds American has the best balance sheet of the group. It has the lowest debt (liabilities to assets) ratio, although with the most working capital. It's cash to debt ratio is also fair, and better than most of the others. British American also has a decent balance sheet, being the second best of the group in my opinion.

Now, none of these companies are in any financial trouble, although Lorillard has a lot of liabilities, way more than anyone else, but their short term current ratio is the best of the group, and they have the best cash to debt ratio.

Altria and Philip Morris' financials don't impress me currently, but they are stabile companies and they know how to operate. I wouldn't be worried about the negative working capital unless the numbers get worse going forward.

Analyst Rating 2.4 2.0 2.5 2.4 1.0
Average Target $28.75 $76.00 $118.86 $39.57 $103.50
Upside 5.82% 9.16% 11.00% 3.91% 12.01%
Strong Buy 2 4 2 2 2
Buy 3 9 1 3 0
Hold 6 4 7 4 0
Underperform 0 0 0 1 0
Sell 0 0 0 0 0
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While analysts seem to like British American the most, there are only two analysts following it, so there's not a ton of coverage on the name. Otherwise, Philip Morris has the best overall rating with a buy, while the others are a buy/hold. Other than British American, Lorillard has the most upside based on current analyst price targets. But remember, most investors are not looking for tremendous growth in the names. 5-10% price appreciation and a decent dividend each year will satisfy most. These are not names to double in a year.

Based on the above numbers, Philip Morris is my top pick of the group. It is the largest name in the group, but still offers the best EPS growth in the group and decent revenue growth. It also offers the best profit margins and analysts like it.

Altria and Reynolds offer the highest dividend yields, but they give you the lowest margins and weakest growth potential. Lorillard has been the best performer over the past year, and offers decent growth potential, while British American is a solid, all around name. You certainly could do a lot worse than any of these names, but if I had to pick one, Philip Morris is it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.