Cigarette makers are sitting pretty. The top five companies by market cap are averaging year-to-date gains of 27.7% as of Oct. 27 compared to less than 4% for the S&P 500. Can they keep it up into 2012? That remains to be seen. What I can say is that investors should consider selling Philip Morris International (NYSE:PM) and buying Lorillard (NYSE:LO) in its place. Here’s why:
Philip Morris International beats while Lorillard misses. The third-quarter results hardly seem like an argument in favor of Lorillard. Nonetheless, I believe there’s a silver lining in all of this. I’ll explain.
First, Philip Morris is a much bigger company doing business in various parts of the world outside the U.S. Lorillard is exactly one-fifth its size, operating solely in the U.S. America is hardly an accommodating jurisdiction for cigarette sales.
Sure, Lorillard is able to carry on a profitable business, but not without the constant threat of litigation. Almost all of Philip Morris’ revenues derive from jurisdictions that either turn a blind eye to their “dirty” business or at least have laxer anti-smoking legislation (some exceptions being Canada, Australia and Singapore) than exists in the U.S. Not to mention cigarette consumption in Asia continues to hold steady if not increase. It makes sense that Philip Morris’ revenues in the third quarter grew 15.9% compared to 3.5% for Lorillard.
But was PM more profitable? Not a chance. Philip Morris’ net margin in Q3 was 11.5% versus 16.5% for Lorillard. LO might be smaller, but it knows how to make money.
Both companies were busy buying back stock in the third quarter. Unfortunately, neither did a very good job. Philip Morris paid an average of $68.27 per share for the 21.2 million it repurchased — a price that was 95.3% of its high for the quarter compared to Lorillard, which paid $109.15 a share for the 4 million it bought back, paying on average 96% of its high for the quarter. Both stocks currently are trading above the price paid per share, so shareholders can breathe a little easier.