One of the industries that I have been most bullish about amidst macro uncertainty is tobacco. Cigarette producers have low betas, sustainable demand, and tremendous emerging market potential that has yet to be appreciated by the market. This is particularly so for Philip Morris International (PM). At this time, I recommend purchasing companies more as a defensive "buy-and-hold" opportunity than a value play.
From a multiples perspective, PMI is cheaper than its peers. It trades at a respective 16.3x and 14.8x past and forward earnings while Altria (MO) - the company it was spun off from - and Reynolds American (RAI) trade at a respective 17.2x and 17.7x past earnings. Interestingly, PMI is the riskiest with its beta of 0.86 and dividend yield of 4%. RAI has a dividend yield of 5.5% and a stabler stock with a beta of 0.59.
At the third quarter earnings call, RAI's CEO, Dan Delen, noted generally positive outcomes:
"Earlier today, Reynolds American announced that its Board of Directors had approved a 5.7% increase in its dividend…
Based on our results through the third quarter, we are tightening our earnings outlook for the full year. We now expect adjusted EPS of $2.63 to $2.68. I would note that our guidance excludes the impact of the individual Engle progeny cases and the Scott lawsuit, as well as implementation and integration costs and tax items…
Overall, I'm very pleased with RAI's solid third quarter performance. I believe our performance reflects both the fundamental strength and positive momentum of our business strategy. These results are particularly noteworthy because they come in the face of a challenging economic and competitive environment. Our third quarter results underscore our ability to manage near-term challenges while continuing to transform our business for the long term in an evolving industry".
Going forward, RAI will benefit from a decision that blocked the FDA's requirement for anti-tobacco graphics to be printed onto cigarette packages. The marketer of well known brands, such as Camel and Pall Mall, is reliant more on package appeal than its competitors are due to a smaller grip on the market. RAI has now raised rough guidance for EPS growth to mid to high single digits. I believe that the producer will easily achieve this target, as its board approved a $2.5B repurchasing program during the next two and a half years.
Consensus estimates for RAI's EPS are that it will grow by 11.6% to $2.78 and then by 6.8% and 6.7% more in the following two years. Assuming a multiple of 16.5x and a conservative 2012 EPS of $2.91, the rough intrinsic value of the stock is $48.02, implying 18.7% upside. Analysts rate it around a "hold".
Greater optimism surrounds PMI. This cigarette producer's business in Asia is considerably undervalued. Wells Fargo (WFC) estimates that revenues from the emerging region could double to around $10B by 2012. Discounting backwards, this interest could be worth $75B. Furthermore, the company retains a strong management that investors believe will deliver high returns. While this sets the bar high, demand has yet to reach its potential due to challenging macro conditions.
Consensus estimates for PMI's EPS are that it will grow by 25.8% to $4.87 and then by 7.4% and 10.1% more in the following two years. Assuming a multiple of 17.5x and a conservative 2012 EPS of $5.19, the rough intrinsic value of the stock is $90.83, implying 17.8% upside. This may not seem like much, but assuming that the company would still appreciate at 15x and a 3.6% miss for 2012 expectations, risk/reward is very strong.