What follows is a list of tobacco companies with various degrees of upside. All of these companies are tremendously safe with their high dividend yields and low betas. Over the last five years, they have trounced the S&P 500. Altria (MO), Reynolds American (RAI) and Philip Morris (PM) gained 78.7%, 33.6%, and 48.9%, respectively, while the S&P 500 fell by 7.1%. While they were particularly attractive during the recession, they are still attractive as income plays during the recovery. My one main concern is whether the Obama administration succeeds in hiking dividend taxes. That will have a deleterious effect on tobacco stocks and, in my view, probably cause the entire industry to underperform others just by itself.
Altria trades at a respective 19.5x and 13.5x past and forward earnings with a dividend yield of 5.1%. Consensus estimates for Altria's EPS forecast that it will grow by 7.3% to $2.20 in 2012 and then by 7.3% and 6.4% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $2.33, the stock would hit $37.28 for 16.9% upside. Coupled with the dividend yield, the risk/reward is highly attractive.
Out of any of the stocks highlighted in this article, Altria is the most liquid. It is the company that ultimately spun-off Philip Morris. And while Philip Morris only focuses on markets outside of the United States, Altria is heavily discounted to egregious assumptions about regulatory and tax pressures. On the other hand, the stock is trading meaningfully above its historical PE multiple.
Reynolds trades at a respective 17.4x and 13.1x past and forward earnings with a dividend yield of 5.4%. Consensus estimates for Reynolds' EPS forecast that it will grow by 5.7% to $2.97 in 2012 and then by 7.4% and 6% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $3.15, the stock would hit $50.40 for 20.6% upside.
Reynolds has the highest dividend yield of its tobacco peers. What attracts me to this company is its strength in smokeless tobacco. Grizzly's has delivered stellar growth and is the leading brand amongst moist-snuff product. Reynolds may never be able to have a cigarette brand as powerful as Altria's Marlboro, but its Grizzly's product seems to promise a lasting reign in chewing tobacco.
Philip Morris International
Philip Morris trades at a respective 17.5x and 15x past and forward earnings with a dividend yield of 3.5%. Consensus estimates for PMI's EPS forecast that it will grow by 8.6% to $5.30 in 2012 and then by 10.8% and 10.6% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $5.84, the stock would hit $93.44 for 6.4% upside.
PMI is attractive to many investors, since it only targets nations outside of the United States. The emerging market focus enables the company to work on attracting a loyal set of customers that are expected to experience surging individual incomes. Tobacco has an inelastic demand and thus can drive sustainable streams of free cash flow. The upside may be the lowest amongst peers, but the stock still is very safe.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.