Vice Investors: Skip Altria, Buy Lorillard Instead
Holding around half the US market share for tobacco products, Altria Group is the country’s biggest, and the world’s third largest manufacturer in the sector. Altria has a capitalization of over $61 billion, and it is known for being a very good mixed growth and dividend stock. Currently paying a $1.64 dividend for a 5.5% yield, the company was a dividend aristocrat until its spin-off of Kraft Foods (KFT) in 2007 and Philip Morris International (PM) in 2008 forced a dividend decrease.
In addition to its handsome dividends, Altria has experienced very good growth in share price as well. Over the past year, the stock has increased more than 18%. It is currently trading around 10% over its 200-day moving average, a position it has held since September, 2011. Although its year-to-year earnings dropped nearly 9%, the tobacco company actually saw a quarterly revenue increase of five percent.
The drop in earnings can largely be attributed to the efforts of the United States and other countries to use taxation to control smoking. Rising federal excise taxes have affected the bottom line of manufacturers like Altria, although the rising costs have also pushed up the revenue for many of these companies. Altria recorded a 2011 gross profit of $9 billion, while rivals Lorillard (LO) brought in $2.3 billion and Reynolds American (RAI) tallied almost $4 billion.
Pressure from the Competition
Both Lorillard and Reynolds have positioned themselves to challenge Altria. Lorillard is the 3rd largest American manufacturer with a market cap of nearly $17 billion. Producing the best-selling menthol brand in the market, the company recorded a 10.2% gain in quarterly revenue and an impressive 19.7% rise in earnings for 2011. In addition, the stock has soared more than 66% in the past year, and the company is paying an amazing $6.20 dividend for a yield of 4.8%.
Like Lorillard and Altria, Reynolds American appears to be coming out of the difficult times. The company has excited investors with fast cash conversion cycle, allowing it to not only make more money, but to also make it faster. With lower debt, inventory and accounts receivable totals, the company is converting product into cash almost three times quicker than it did in 2007. This flexibility is very important for the $25 billion company, as it looks to jump from its number two position to the top spot.
Is Altria the Best Buy in Big Tobacco?
While the outlook for each of these companies appears to be bright, which is the better value going forward? Each has plusses and minuses, so we’ll summarize. Altria is the big business on the block. It has more resources and revenue at its disposal. The problems here are price and debt. The company’s book value has tumbled, and even though its forward price to earnings is just under 13, the price to book ratio is a brutal 16.6. Add that to $13.7 billion of debt that is causing a debt to equity ratio of a staggering 368, and I am concerned about the possibility of a bankruptcy somewhere in the company’s not-too-distant future.
Lorillard posted double-digit gains in revenue, earnings and share price over the last 12 months, and it pays a monster dividend that attracts a lot of investors. The concern with this company is its rising payout ratio (already at 65%), a number which is obviously getting noticed by the institutional investors who hold nearly 98% of its stock. Almost 4% of Lorillard’s stock float is held in short shares, a number that dwarfs the 0.7% of Altria. Where there’s smoke, there’s usually fire; I think this large number of short shares could be that smoke.
Reynolds American posted a huge 20% earnings gain and has the biggest yield of the three at 5.3%. The company’s debt to equity ratio is a manageable 58, and like its competitors, it is sitting on a big stack of free cash flow. The concern with the company is its lack of quarterly revenue increase, as well as a price to book ratio approaching 4 that suggests the stock is overvalued. Without additional revenue streams or overhead cuts, Reynolds could end up seeing its debt soar.
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