This is the end of the series on valuing Altria (MO), Lorillard (LO), Reynolds American (RAI) and Phillip Morris (PM). These firms have been declining in share price recently and now is a good time to examine them. Below I will discuss the analysis presented in the previous articles and make a recommendation based on the firm(s) with the most positive value relevant fundamental factors. Here is the list of previous articles:
- Valuing Big Tobacco, Part I
- Valuing Big Tobacco, Part II
- Valuing Big Tobacco, Part III
- Valuing Big Tobacco, Part IV
- Valuing Big Tobacco, Part V
- Valuing Big Tobacco, Part VI
- Valuing Big Tobacco, Part VII
Financial Performance and Position
When we consider top-line and bottom-line growth, we can exclude Altria from consideration as a long-equity investment. The same thing can be said of cash flow from operations.
In terms of total equity, all firms except Reynolds America did a horrible job of increasing total equity. That seems to be the trend in this industry. Also, the industry trend seems to be towards increasing liabilities.
When it comes to profitability, Lorillard was the most profitable firm between 2009 and 2011. Reynolds became the second most profitable firm in 2011. However, Altria may still be the second most profitable firm in the group in future years. Phillip Morris lead the group in return on equity in 2010 and 2011. That said, Lorillard and Phillip Morris lead the group in return on assets.
In 2012's first half, the financial performance of all four firms was towards top-line and bottom-line growth. In terms of total equity in the first half of the year, Altria and Reynolds increased total equity while Phillip Morris' total equity turned negative. Altria and Reynolds performed the best in the first half of the year in terms of profit margin. Lorillard and Phillip Morris had the highest return on assets in the second quarter.
In terms of the present value dividend discount model, Altria and Reynolds are the most undervalued. That said, all four firms are undervalued based on that model. In terms of price-sales, Lorillard and Phillip Morris are valued in my comfort zone.
Altria and Lorillard's revenue-share are forecasted to increase in the second half of the year. Further, Altria and Lorillard have the most upside based on my estimated valuation ranges.
The tobacco firms aren't as sensitive to the economic cycle as other firms. The demand for tobacco products isn't very sensitive to changes in price or income. That said, I think we could see increases in the price of tobacco products as subsidies expire and budget deficit reduction measures are signed into legislation.
Further, the Fed's decision to purchase mortgage-backed securities should have a negative impact on US Treasury prices. In other words, the increase in US Treasury yields could adversely impact the demand for the dividend yield of tobacco firms.
All four firms are investment grade in terms of volatility. That said, Lorillard's monthly returns are skewed to the upside. Also, Lorillard and Altria provide the most diversification benefits.
My preference is for Lorillard based on valuation, financial performance and position, and diversification benefits. We are going to have to watch interest rates to see how they perform over the coming months. Also, investors could consider Reynolds American. Reynolds may sustain the advantage as the second most profitable firm of the four. Even if it doesn't, the firm is still one of the more undervalued firms based on the present value dividend discount model.