Altria Group, Inc. (NYSE:MO) spun off its international operations in 2008, which now trades as a separate company, Philip Morris International Inc. (NYSE:PM). Altria focuses on the U.S. market, while Philip Morris is focused on international markets. Although Altria is considered the more stable company, with less growth opportunities, it has identified various opportunities within the U.S. that extend beyond tobacco. This includes its almost 30% stake in the brewing company, SAB Miller.
Although the cigarette industry as a whole is expected to see mid-single decline over the next few years, Altria is expected to see a revenue increase of 5% in 2012. This is driven by a diverse product mix and initiatives for restructuring manufacturing, where they expect to save $400 million by the end of 2013.
Altria is the U.S. leader in cigarette sales market share at 50%, with Reynolds American, Inc. (NYSE:RAI) coming in at second around 30%. Reynolds is expected to have a down year, with revenues down 1% from 2011. The company is managing to keep revenues relatively in line due growth in its top brands, Camel and American Spirits, but other lower margin brands continue to struggle. Part of what gives Altria an advantage over Reynolds, is that Reynolds’ top brands are susceptible to trade down.
The third big player in the U.S. cigarette industry is Lorillard Inc. (NYSE:LO), with around 10% of the market. Lorillard saw sales up 10% in 2011 and expects sales up 4% in 2012 on market share gains thanks to the company’s top brand Newport. However, if the FDA’s ban of menthol ever came to fruition, it would be detrimental to Lorillard.
British American Tobacco PLC (NYSE:BTI) missed first half 2012 sales on declining organic volumes. Organic volume was down 0.6% for the first half, versus being up 0.7% in 1Q. The company is seeing pressure from international markets, including slowing demand from Italy, Turkey, Egypt, Japan and Brazil. The decline in these countries overpowered the modest volume growth in Russia and Asia. British American was powered by its Lucky Strike brand in the first half of the year, with volume up 19%. The company is also expected to grow EPS 8% this year despite its exposure to a weak European economy. We believe that even though the company is expected to have positive growth next year it still trades too rich on a valuation basis.
The tobacco companies appear to trade in a tight range on a P/E and P/S basis, with British American being the clear outlier, trading above its peers. Altria and Lorillard are in a tight race for being the most undervalued company in the tobacco industry.
| P/E | P/S | Dividend Yield (%) | |
| Altria | 15 | 2.9 | 5.3 |
| Reynolds | 18 | 2.8 | 5.5 |
| Lorillard | 14 | 3.4 | 5.4 |
| Philip Morris | 18 | 2.0 | 3.7 |
| British American | 20 | 4.0 | 4.1 |
The fund interest in Altria includes five funds that had over 4% of their 2Q 13F portfolio invested. Wintergreen Advisors had over 13% of its 13F in the company, while Adage Capital, Jim Simons and Cliff Asness also owned at least 1 million shares at the end of 2Q. Also worth noting is that Wintergreen Advisors is the top fund owner in Reynolds American, with 9% of their 13F invested in the company. Wintergreen also shows up as the number two fund owner by shares in Philip Morris, with 11% of their 13F invested in the company—see all of Wintergreen’s holdings here. We believe that Altria has made key strides to maintain its position as the leader in the cigarette market, but that it also appears to be positioned well to benefit from increased demand for smokeless products.
Even though the U.S. cigarette market has been in decline since 2009, Altria’s acquisition of the smokeless tobacco company UST Inc. gives it another competitive advantage. Altria’s revenue from smokeless products was up 5.4% in 2011, with smokeless products operating income up 7.1%. As well, smokeless products are a higher margin item for the company. The company is focused on expanding its product mix to help mitigate the constant ligation that the tobacco industry faces, and we believe Altria is better positioned to do so relative to its peers.
