Altria Group Inc (MO), Reynolds American, Inc. (RAI), Philip Morris International Inc. (PM): There Is Trouble Brewing at Two Defensive Tobacco Companies

Bigger problems

Reynolds American, Inc. (NYSE:RAI) has a bigger problem than negative equity. The company is facing the loss of 30% of its sales if menthol cigarettes are banned in the US. This issue has recently been reignited again after the FDA opened the discussion to public consultation last month. Meanwhile, Lorillard is facing total bankruptcy if menthol is banned, as nearly 90% of the company’s sales come from menthol products.

*Figures in millions

The EBIT figures I have used above are a prediction based on the company’s revenue after a 30% loss of revenue. As the table shows, if this were the case, by the half-year 2014, Reynolds American, Inc. (NYSE:RAI) would be paying out 15% of EBIT in interest to finance is growing debt pile. Bear in mind also that the company’s current dividend commitment runs at $350 million a quarter. Plus, a continuation of buybacks at the current rate of $150 million a quarter indicates that the company will find it hard to exist if menthol products are restricted, something I would not like to have hanging over my investment.

Conclusion

Borrowing to buy back stock is fine, but one day Reynolds and Philip Morris will have to pay back this debt. With tobacco consumption declining, paying back debt is going to become harder. As a long-term investment, Altria Group Inc (NYSE:MO) looks to be the best bet.

The article There Is Trouble Brewing at Two Defensive Tobacco Companies originally appeared on Fool.com and is written by Rupert Hargreaves.

Fool contributor Rupert Hargreaves owns shares of Altria Group (NYSE:MO). The Motley Fool owns shares of Philip Morris International.

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