In regard to the current fundamentals, Altria trades at a respective 16.8x and 13.5x past and forward earnings. This, in my view, appears reasonable in light of the 20x industry average. If just the discount to peer multiples were closed, the stock would soar 15% on top of an already stellar 5.1% dividend yield. 7.3% annual EPS growth is expected over the next five years–relatively predictable in light of the simplistic business model (ie. it’s not terribly difficult to forecast penetration rates, prices, and usage trends with past data). Think about this: If the company just does what it is expected to, it will provide annual returns of 12.6%–not bad for a company with less than half the volatility of the broader market. If it adds on a new high-growth marijuana subsidiary, it could, however, increase the market’s expected growth rate and thereby justify a higher valuation.
Reynolds American, Inc. (NYSE:RAI) Product Strategy
Reynolds America is also a leading tobacco company. In a recent study, it was evident that graphics warnings on cigarette packets may be instrumental in helping people quit smoking. This comes as a relief to public health advocates eager to get the surgeon general’s approval. With such findings, is it still wise to invest in tobacco companies like Reynolds American?
Companies have definitely taken note, and they are working hard towards fighting back. A major strategy that has been put to use is product diversification and price hiking. Reynolds has entered the e-cigarette and smokeless tobacco categories. It has also tried to thin down cigars to make them look more like cigarettes…but of course without the regulations. However, with companies like Altria selling superior brands such as Marlboro, it becomes difficult for smaller ones like Reynolds to have a significant impact on the market.
Reynolds is being rated as a “hold” by most analysts. According to FINVIZ.com, the consensus rating is a 2.9 out of 5 where “5” is a “sell.” However, TheStreet rates it as a “buy” due to the company’s growth per share and its good return on equity. The company’s positive outlook should also keep investors glued on the upside.
Conclusion: Should You Invest in Reynolds, Altria, or Neither?
With Reynolds, you get a company that is relatively cheaper at 13.1x forward earnings with slightly lower (and less predictable) growth prospects than Altria. Reynolds is forecast around a 50 bps lower growth rate over the next five years. Altria has a 23.7% return on invested capital–roughly double Reynolds’s. So, all things considered, I strongly recommend an investment in Altria over Reynolds.
However, with that said, I find that there are stronger tobacco companies than Altria out there. Lorillard Inc. (NYSE:LO) is incredibly cheap at 14.5x past earnings and a 5.2% dividend yield. What is particularly impressive is that it trades at such a discount to its peers despite having a much stronger growth rate for the years ahead. It has grown by a rate of 11% over the past five years, and I have little doubt it will be able to replicate this success in the years ahead. It therefore makes sense to balance an investment in an established company like Altria with a company coming off of a sharp growth curve. Furthermore, if any of these large-cap firms were to explore the marijuana industry, it would ignite investor interest in the upside just like other small-cap stocks already have.
The article Why You Should Invest in Tobacco & Marijuana originally appeared on Fool.com and is written by David Gould.
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