By Renee O'Farrell
People love their "sin" products and, for the most part, they are willing to pay the premium that keeps these companies going. For my part, I love these people for loving their sin products - it makes those companies a great investment. No matter which side of the "smoking or non" battle you fall on, one thing is clear - there is a lot of money to be made on cigarettes and other tobacco products.
Just look at the big tobacco companies, like Altria (MO).
Altria is a high-yielding dividend stock with a long history of strong performance - a combination that makes it pretty attractive to investors looking for a way to generate bigger returns than the low interest rates currently on offer. The company has a dividend over 5% (the stock recently traded for roughly $30 a share) and is an exceptionally strong performer. Since September 1, 2008 through March 19, 2012, Altria has returned over 80%, with almost 27% of that coming from the last 52 weeks alone. You won't find that type of profile from a health food company or exercise facilities chain - earnings in these companies are just not as consistent as tobacco - and forget the market. It returned less than 1% in 2011.
Altria also has some of the top brands in tobacco. Altria's flagship brand Marlboro is responsible for over 40% of the cigarettes sold in the US and its smokeless tobacco brand portfolio accounts for over 55% of the market. This stock is actually a favorite of mine because, in addition to top cigarette brands like Marlboro and Virginia Slims, it sells wine. To me, that is a neat little piece of diversification. After all, nonsmokers prefer wine - not that Altria is so one-sided or anything. The company also owns over 27% of SAB Miller (SAB), the brewing company that sells popular beers like Blue Moon, Coors Light, Miller Genuine Draft and Miller Lite.
Of course, that's not to say everything with the company is perfect.
At the end of October 2011, Altria announced that it would be cutting the number of salaried workers it employs by 15 percent thanks to declining cigarette sales across the country (Altria's operations are based entirely in the US). The company is also going through a change in management; its CEO Michael E. Szymanczyk is slated to retire. Current Vice Chairman Martin J. Barrington will take over the reigns after Szymanczyk's retirement becomes official in May, after the annual shareholders' meeting. I'm not worried about Barrington as CEO - he has been with the company since 1993 and has held a variety of positions with the company during that time. I think that his bank of varied experience will serve Altria well, but there is bound to be some period of adjustment - there always is.
The only question is how will Altria handle it?
Right now, Altria is positioned fairly well. Its revenue growth has been outpacing its industry, moving up by 5% compared to its industry's approximate 1%. However, the increase did nothing to buoy the company's earnings per share, which actually declined. The company's gross profit margin also slipped slightly, but it remained strong, with its net profit margin stayed pretty favorable compared to its peers.
Altria did much better with regard to its return on equity, going from 75.21% at the end of the fourth quarter 2010 to finish Q4 2011 with a return on equity of over 92%. This points to strength within the company. Further, Altria was able to keep its cash flow constant - a fact that further speaks to its strength given that its peers' cash flows lost over 28% on average. The company is also priced low. It is trading at just 12.72 times its future earnings, while its peers have a forward price to earnings ratio of 15.82.
In comparison, rival Reynolds American (RAI) is priced marginally higher than Altria, with a forward price to earnings ratio of 12.85. Also, the company, which is responsible for the Camel, American Spirit, Winston, Kool and Pall Mall brands, has enjoyed growing revenue but that growth is failing to keep up with the rest of its peers. Reynolds American's revenue grew by just 0.1% since the same quarter last year and its earnings per share actually decreased. Its earning per share also took a hit in terms of quarter over quarter. The company was able to increase its net operating cash flow significantly quarter over quarter, boosting that figure by 117.66%. Yet, with a quick ratio of just 0.51, Reynolds American could still have difficulty covering its short-term cash needs.
Over the last 52 weeks, Reynolds American's share price has risen almost 29%. It recently traded for around $41 a share. Analysts give the company a mean one-year target estimate of $42.60, with a range of $38 to $56. Given how close the mean is to the lower end of the range, it is fair to say that most analysts are predicting modest growth at best, and I have to agree. This company does pay a high $2.24 dividend (5.40% yield), but that is about all I see to its advantage. Sure it does have strong cash flow and good stock performance, but will it continue to produce those numbers going forward? I doubt it.
Reynolds American doesn't have the diversification Altria does to help sustain it as the tobacco market in the US constricts - the only protection it has against a declining tobacco market is its Niconovum AB brand of smoking cessation products (sold in Sweden under the name Zonnic). Plus, the company is in the process of restructuring its operations. According to a press release dated March 14, Reynolds American is planning to cut roughly 10% of its workforce by the end of 2015, for a savings of around $70 million a year - and that's just on the salaries. The release says that the figure will be closer to $110 million a year once benefits and others costs related to the eliminated positions are included. With all this, I rate Reynolds American a hold, at best. The company will likely come back around but now is not the time to buy.
Turning our attention to Lorillard (LO). This is the smallest of the big three tobacco companies in the US and the least diversified. The company has 43 different brands of cigarettes, the most popular of which is Newport and Maverick, but as far as diversification those, that's it. Lorillard only makes cigarettes.
Granted, it has done well at its business - the company's share price swelled 55.11% over the last 52 weeks. Right now, the stock is trading around $130 a share with a $6.20 dividend (4.70% yield). Analysts, in general, are a little more optimistic about where the stock will go going forward than they are with Reynolds American. They give the company a mean one-year target estimate of $133.63, with a range of $115 to $146. But that makes perfect sense given that Lorillard is in a better position than Reynolds American.
Lorillard has had high revenue growth of over 10%, which in turn boosted its earnings per share. Further, the company has more than enough cash to cover its short term needs, with a quick ratio of 1.17, helped largely by an earnings growth of 33% and a net operating cash flow increase of almost 19%. Plus, the stock is priced low at 13.26 times its future earnings - but I'm not buying.
Don't get me wrong, this stock has a great profile, but Altria is in a much better position. It is better diversified and has the brands in its portfolio that lead market, at least as far as tobacco is concerned, not to mention it pays a higher dividend and is priced lower.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.