For investors looking for strong defensive plays to hedge against a double dip, tobacco is an excellent industry to start exploring. My Altria (MO) and Philip Morris International (PM) picks have done well while returning strong dividends. The only real problem going forward is the potential for the Bush tax cuts - especially for dividends - to be cut. This would not only be deleterious to the economy, but to the stock market and tobacco firms specifically. From greater regulatory pressures to concerns over the tax environment, tobacco is likely to experience greater volatility as brands are once again put to the test. The fundamentals, however, are strong and will drive greater risk-adjusted returns.
From a multiples perspective, tobacco is reasonably priced. PMI trades at a respective 16.6x and 15.5x past and forward earnings with a dividend yield of 3.8%. Altria and Reynolds American (RAI) trade at 17.8x and 17.5x past earnings, but have lower forward PE multiples. PMI's PE multiple is still 82% of the historical 5-year average.
At the fourth quarter earnings call, PMI's CEO, Louis Camilleri, noted excellent performance:
2011 was a superb year for Philip Morris International. We returned to organic volume growth, thanks notably to our strong performance in Indonesia and in Japan, where we benefited from our excellent execution in response to the tragic events there last March.
We achieved global share growth for the fourth consecutive year, driven by our superior brand portfolio. Our solid volume performance, strong pricing and significant productivity savings led to record profitability. Finally and perhaps most importantly, we continued to generate strong cash flow, which enabled us to provide generous returns to our shareholders.
The company is the largest tobacco company in the world, and is either ranked first or second in every area in which it sells products. This enables the firm to be a price leader and drive industry movement in margins. PMI further has a conservative balance sheet and greater visibility over earnings. The absence of exposure to the United States substantially mitigates regulatory and tax headwinds.
Consensus estimates for PMI's EPS forecast that it will grow by 7.6% to $5.25 in 2012 and then by 11.2% and 10.8% in the following two years. Assuming a multiple of 17.5x and a conservative 2013 EPS of $5.77, the rough intrinsic value of the stock is $100.98, implying 25.5% upside.
Altria has turned over a new leaf with a 16 bps y-o-y market share gain in January - the first rise in over a year. It also had the second strongest volume in January, behind only Lorillard (LO), which seen its Newport and Maverick brands become increasingly popular. Fourth quarter results for Altria were strong, growing 14.5% to $0.50. On the other hand, a lack of promotional spending for Marlboro resulted in retail volumes falling 0.6%. At the same time, the company will need to trim costs to drive margins. Towards that end, management announced a $400M cost savings initiative that may boost margins by around 100 bps by 2013.
Consensus estimates for Altria's EPS forecast that it will grow by 7.3% to $2.20 in 2012 and then by 7.7% and 6.3% in the following two years. Modeling a 3-year CAGR of 7.1% for EPS and then discounting backwards by a WACC of 9% yields a fair value figure of $32.27, implying 10.5% upside.