Altria (MO) reported earnings recently, and although they beat estimates, the market was not that excited about the leading tobacco stock. On the face of things, it was a great report with 15% year-over-year growth, a new $1 billion buyback and higher guidance. But the stock is essentially flat since the date of the earnings report.
Global tobacco giant Philip Morris (PM) international had similar results when they reported earlier this month. Phillip Morris had 32% earnings growth before currency adjustments, gave positive guidance for the rest of the year and announced a new agreement with Swedish Match to produce smokeless tobacco products. The stock had a post-earnings pop but has traded sideways since then.
Apparently, no one is all that excited about the tobacco stocks at these levels.
The Problem With Tobacco Stocks Right Now
For most of my career, tobacco stocks have been thought of as the ultimate defensive stocks. They sell a highly addictive product with huge margins, and they produce massive cash flows. Tobacco stocks usually have very good dividend yields and have long been a staple of growth and income portfolios.
Both of the leading tobacco stocks still yield more than the market, with Altria yielding 3.8% and Phillip Morris International paying 4.7% but neither is exactly cheap right now. In addition, revenue and earnings growth has been fairly modest over the past few years, and many analysts expect it slow further in the years ahead.
I pulled up a list of tobacco stocks and found that the whole industry has this problem right now. No tobacco stocks are growing particularly fast; Altria and Reynolds American (RAI) lead the way with average annual earnings growth of about 8% over the past five years. Universal (UVV) and Vector Group (VGR) both have negative five-year earnings growth.
Smoking is more popular in some parts of the world than it has become here in the United States, but the truth is that, each year, more people quit and fewer take up the habit around the world — and that trend is probably irreversible.
Tobacco stocks aren’t cheap on any of my favorite metrics, either. No tobacco stocks trade below book value right now. Universal Group is the cheapest at 1.1 times book value. It is also, along with Alliance One (AOI) the only one trading with a single-digit enterprise-value-to-EBITDA ratio right now. In spite of slow growth and average prospects, no tobacco stocks are trading at levels that would qualify as a bargain purchase right now. Price-to-earnings ratios in the group are mostly over 20, with only Phillip Morris International and Universal trading below that level.
Tobacco stocks can be a solid addition to the portfolio because an addictive product can be a wonderful business. However, everything has a price at which it is a bargain and tobacco stocks are nowhere near that point right now. Charlie Munger is fond of saying that he didn’t get rich by buying mediocre opportunities, and at the moment tobacco stocks are a mediocre buy at best.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities. He is the author of the Banking on Profits newsletter covering the community bank stock opportunity and the Deep Value Report that seeks out undervalued stocks that are likely to survive until they thrive and capture the value effect that has been proven to beat the market over time.
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