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It is always interesting to see how the most popular and well-covered stocks are performing. While often times popular stocks are strong performers, sometimes the best value is in markets that investors don't frequently pay as much attention to.

Few sectors or stocks have been more popular than dividend stocks over the last several years. With cyclical companies such as Boeing (BA), GE (GE), and Caterpillar (CAT), offering minimal returns in the last decade, investors have turned to more stabile companies with strong and consistent dividend records.

(www.thestreet.com)

Tobacco companies have consistently been some of the most popular dividend stocks over the last several years. While Altria (MO), Reynolds (RAI) and Lorillard (LO) are the most popular U.S. tobacco companies, international tobacco companies such as Phillip Morris International (PM) and British Tobacco are very popular as well.

I've been positive on tobacco stocks from some time, writing that I thought Lorillard was significantly undervalued over a year ago and more recently arguing that Phillip Morris International is likely to trade over $100 a share over the next year.

Still, most U.S. tobacco stocks are now trading at or near fifty-two week highs even though most analysts are projecting mid-single digit growth for these widely owned companies over the next five years. Many global tobacco companies, such as Phillip Morris International, are also trading at or near fifty-two week highs as well.

To me, the best value in the tobacco sector is abroad. I think that Japan Tobacco (OTCPK:JAPAF) is likely the most undervalued tobacco stock in the market today.

Japan Tobacco is $62 billion tobacco company that trades at 13x trailing earnings. The company's growth and margins compare favorably to Phillip Morris International, and the stock is also significantly cheaper than its U.S. peer using a number of important metrics.

Japan TobaccoPhillip Morris International
Price/Sales2.3x2x
Price/Cash Flow10.5x15x
Operating Margin25%17.5%
Gross Margin57%27%
Payout Ratio26%61%

(www.etrade.com)

Japan Tobacco's numbers are a bit skewed by the strong recent growth the company has had over the last several quarters after the earthquake and subsequent tsunamis crippled the company's business in 2011. Still, Japan Tobacco has industry leading growth and margins, and the company trades at a discount to most of its peers.

(www.marketwatch.com)

Japan Tobacco has consistently had stronger margins and more impressive recent growth than Phillip Morris International, and the company continues to benefit from a weaker Yen as well.

While Phillip Morris International has consistently had strong growth and cash flow over the last several years, the company still trades at a premium multiple to its peers. PhillIp Morris International trades at 18x trailing earnings and 15x cash flow. Phillip Morris International does have a significantly higher return on equity than Japan Tobacco, but that is largely because the company has heavily leveraged its balance sheet with significant share buybacks over the last several years. Phillip Morris International was able to increase the company's market share in Japan by nearly 10% after the earthquake and subsequent tsunami in early 2011, but Japan Tobacco has recovered nicely since this severe disruption to the company's business. This past quarter Japan Tobacco reported that the company had increased its Japanese market share from 55% to 60% in the just the last six months.

Japan Tobacco has just a 26% payout ratio, and while the company's yield is just 2% today, there are strong signs that management will likely significantly raise its dividend in coming years. The Japanese government currently owns 50% of Japan Tobacco, just recently the Japanese government formally began openly discussing selling most its stake in the company to finance reconstruction efforts. Analysts expect Japan Tobacco to initiate a large share buyback and raise the dividend significantly once the government sale is completed. New shareholders will also likely increase pressure on the company to raise the dividend and payout ratio, and management could also borrow significantly at fairly low rates to give the company more flexibility moving forward.

To conclude, Japan Tobacco was temporarily crippled by the earthquake and subsequent tsunamis in Japan last year, but the company has recovered nicely over the last several quarters. While the Japanese government is proposing raising the tobacco tax, minority parties continue to oppose this measure. Also, U.S and European tobacco companies have gotten most of the attention of dividend investors over the last couple years. Still, Japan Tobacco should benefit significantly in the next year from government divestments, reconstruction spending and a falling Yen. Stocks with strong dividends are always appealing, but with the companies with strongest current cash flow and growth are likely to be able to return more cash to shareholders over the long-term.

Source: A Significantly Undervalued Tobacco Company With Strong Growth And A Low Payout Ratio