Philip Morris Vs. Other Tobacco Companies: Growth Potential Plus Current Yield Solidifies Long Case

| About: Philip Morris (PM)

Since my first article "Southern Copper vs. Freeport-McMoRan: Higher Yield Tips The Scales" was well received by a lot of people for its short and precise format, I would like to proceed with these "Stock A vs. Stock B" articles as a series, if I continue to receive good feedback about the format and the series in general. For those of you who did not read the first article of this series, I do not intend to slam any stock. I just present my analysis and would appreciate any constructive feedback and discussion in the comments section.

Part 2 of this series involves Philip Morris International (NYSE:PM) vs. Altria (NYSE:MO) vs. Lorillard (NYSE:LO) vs. British American Tobacco (NYSEMKT:BTI). I've purposefully left out Reynolds American (NYSE:RAI) from the article to keep the balance: two US only companies (MO and LO) and two International companies (PM and BTI). Also, I've ignored small(er) cap companies like Vector Group (NYSE:VGR) and Universal Corporation (NYSE:UVV). I mentioned in my first article that I would not cover the same points in the pros and cons of the companies I am dealing with, but its particularly difficult in this case as it involves 4 stocks. So, one or two points might get repeated but I believe those are really needed to drive the point home. So here we go.

Pros of PM:

  • High Growth Potential: Operating in more than 150 countries throughout the world, PM has fantastic growth potential. Currently, PM has the largest global market share at about 15%. For investors with patience, I see this stock being the "Altria of the next 25 years" - that is, the best performing stock
  • Decent dividend yield and growth: At the current price, PM yields about 4%, and I expect a dividend increase (say to 85 cents per quarter) in September 2012 based on its dividend increase history

Cons of PM:

  • Most Volatile: This stock is the most volatile with a Beta of 0.93. For those of you not familiar with the term "Beta", it indicates the volatility of the stock. Example: If the market moves up by 10%, a stock with a Beta of 1 moves up by 10% as well. If the market goes down 10%, a stock with Beta 2 goes down 20%. With its exposure to Europe and the ongoing Europe mess, PM might be considered more risky than usual at the moment
  • Competition: While the highly regulated US market impedes new companies, Philip Morris has to face tough competition in the international markets from companies like British American Tobacco, Imperial Tobacco Group (ITYBY.PK), and Japan Tobacco

Pros of MO:

  • Reliable Dividend: Highest current yield of the companies in question at 5.7%, with continuous dividend payments from the year 1970
  • Lesser Competition: High regulations, ban on public smoking, and tons of lawsuits make sure the barriers to entry are quite high. Peter Lynch, the legendary investor of 1970s and 1980s, favors companies with niches and less competition (and his book "One up on Wall Street" was the first investment book I read/heard and is one of my favorites)
  • Pricing Power: Talk with a regular smoker and you will know they will not hesitate a few pennies more for "their Marlboro". I would like to add Charlie Munger's (Warren Buffet's investing partner) famous quote on pricing power "If you know you like Wrigley's Gum and you see it there for two bits, are you really going to reach for Glotz's Gum because it's 20 cents and put something you don't know in your mouth? It's not worth it for you to think about buying an alternative gum. So it's easy to understand why Wrigley's Gum has such a huge advantage."

Cons of MO:

  • Debt: Altria's free cash flow and debt are points of concern for those looking at balance sheets
  • Lawsuits and Lobbying: Altria spends millions of dollars dealing with lawsuits and lobbying. While I agree these companies are so used to lawsuits, there is no denying it affects the bottom-line.

Pros of LO:

  • Least Volatile: Of the 5 stocks in question, LO has the lowest Beta of 0.29, which would be good for investors who do not really like the stock price to skyrocket one time and fall crashing the next
  • Lower Valuation: Knowing the stock has risen over 50% since early 2011, it's hard to believe this stock actually has the lowest current PE amongst the stocks considered here.

Cons of LO:

  • Over dependence on Menthol cigarettes: The stock typically rises by a big percentage on good news about menthol cigarettes. Expect it to fall by a bigger number if and when a bad news breaks out about Menthol cigarettes.

Pros of BTI:

  • Biggest International Presence: BTI operates in more than 180 countries, the highest in terms of number of target markets. Russia, Germany, and Brazil are some of the countries where BTI is really strong in sales.
  • Acquisition King: BTI can perhaps be called the "King of Acquisitions" in the tobacco industry. While other companies have strived to increase market share by introducing new products or through other metrics, BTI has historically been built on acquisitions, and successful ones at that. And guess what, since acquisitions present a lot of overlaps in operations, it presents BTI with total control - BTI continuously eliminates extra costs, while retaining just the part of the business that it needs. Some of its acquisitions over the past few years can be found here, here, and here.

Cons of BTI:

  • Dividend History: Its dividend history is nothing to shout about when compared to the other companies listed here. Please click here for more details. Also, the current yield of 2.6% is the lowest of the 4 companies
  • Slightly Higher Valuation: Amongst the 4 stocks, BTI has the highest PE of 18.41 at the moment.

My Decision:

I've decided to have PM as my sole tobacco stock. I held MO till about a week ago but I sold it for a nice gain when it reached $29-$30 range. Philip Morris wins because of its unique positioning as a growth and income stock. PM's growth prospects are definitely higher than that of LO and MO, while PM's dividend current yield and dividend growth potential make BTI's dividend part look very weak. I still like MO but to keep my portfolio diversified, I would like to keep just one stock in each industry.

Other investors might prefer other names; say Altria's (which I still like, for the records) higher yield would attract those looking for higher current income. Picking one stock over the other is not as simple as just looking at the PE or current yield, in which case I would have picked LO over PM.

Please feel free to leave your comments and feedback below, including which of these stocks, if any, would you own if you are to own just one of these.

Additional Disclosure: Investing in cigarette companies invokes different emotions in different people. Some see it as a profitable investment, while others see it as morally wrong. This analysis is strictly meant for investment purposes and does not endorse smoking.

Disclosure: I am long PM.