In a victory for the First Amendment, recently the Washington D.C. Court of Appeals upheld the decision of a lower court to prevent the FDA from mandating that large graphic warnings must be placed on cigarettes sold in the United States. This is in contrast to a Cincinnati court decision in March ruling that such a law is constitutional. As a result, this issue may be going to the Supreme Court in the near future.
Now, in western countries smoking is on the decline, so I prefer Philip Morris International (PM) with global market exposure over heavily U.S.-based companies, but that does not mean there is no money to be made in domestic tobacco. So out of the major U.S. tobacco companies, Altria (MO), Lorillard (LO), Vector Group (VGR) and Reynolds American (RAI), which is in the best shape for growth in the years ahead? I recently compared international tobacco giant British American Tobacco with PM in a previous article, and in this one I will compare the domestic tobacco companies.
All companies pay a good to great dividend, with VGR leading the pack with a 9.3% yield. MO, RAI, and LO follow with yields of 5.2%, 5.2% and 4.8%, respectively. In terms of 10-year performance, the opposite trend is seen with LO leading, MO and RAI being comparably intermediate, and VGR being the worst performer.
(All data used in the below calculations are from MSN Money)
First, we will compare the profit margins of each company. The big loser here is VGR with profit margins decreasing from almost 40% in 2007 to only 21% in 2011. Lorillard, with relatively consistent margins between 36% and 42% in the last five years is comparable with Altria between 38% and 40% in the same time frame. The winner here is RAI, which has increased margins from 45% in 2007 to 47% in 2011. However, all are inferior when compared with international company PM, at a margin of 66% in 2011.
When we look at the selling, general, and administrative costs of all four, we again see a division into clear winners and losers. RAI and VGR have spent consistently around 40% of gross profit on SGA expenses in the last 5 years. Over the same time period, LO has been quite consistent at around 20%, the clear winner here. MO is an interesting story in this case, in 2007 the company was spending 40% of gross profit on SGA expenses, but by 2011 this had declined to 30%, the only company of all four to show a large consistent decline.
The profit as a percentage of revenue shows a similar trend. Again, the loser here is VGR with 13% profit as a percentage of revenue in 2007, declining to 3% in 2009, and up to 6% in 2011. Neither MO nor RAI show a trend of consistent increase or decrease with profit as a percentage of revenue values ranging from 14% - 17% and 11% - 16%, respectively. Lorillard shows the highest margins of all four; however it does show a rather unfortunate declining trend. In 2007, LO was at almost 23%, but by 2011 that had decreased to 17%.
When it comes to debt, MO and RAI show asset to liability ratios of 5.7 and 1.6 for 2011, with no strong trend over the last five years. LO and VGR fall on the opposing side, with more liabilities than assets at 0.62 and 0.88 for 2011. Over the last five years this ratio for both has been steadily declining from 0.75 and 0.95 five years ago for each, respectively. However, when we look at the number of years required for each company to pay off all long-term debt with net earnings, we see an increase from RAI to LO to MO to VGR with 1.8, 2.3, 3.8, and 6.9 years, respectively. Of these, MO, LO, and RAI all have approximately maintained or reduced payoff time over the last five years, whereas VGR's has been very erratic, requiring up to 20 years in 2009.
When we look at the retained earnings of each, RAI and VGR both have negative retained earnings where MO and LO have been able to increase their retained earnings over the last five years. Here, LO has a slight edge over MO as in 2009 MO had a single year of decreasing retained earnings (by 0.1%) whereas LO increased by 7%.
So now with all the data above, which company is the best investment? I have to instantly eliminate VGR for massive debt and negative retained earnings, despite its huge dividend which we cannot see to be sustainable. RAI gets eliminated next as a company that is making massive profits should have more retained earnings than it does. MO pays a similar dividend to RAI, but still has higher retained earnings. So we are down to MO and LO. LO having a lower assets to liabilities ratio does not concern us as LO can still pay off its debt even faster than MO; LO seems to have the edge. Despite being an MO shareholder, we need to give the winners spot to LO. The highest profit as a percentage of revenue, lowest SGA expenses, least damaging debt, and high retained earnings all point to LO being a better investment than MO.
Disclosure: I am long MO.
Additional disclosure: While I am long MO currently I will likely replace it with, or add, LO