Philip Morris Is No Longer the Best International Tobacco Company

Philip Morris has been replaced by smaller peer British American, which is better placed for growth.

Jun 27, 2014 at 8:00AM

In the world of big tobacco two companies virtually control the international market. British American Tobacco (NYSEMKT:BTI) and Philip Morris (NYSE:PM) together control around 45% of the international market, excluding China.

Both companies are great investments, but for US investors at least, Philip Morris tends to be the company of choice. However, British American has many attractive qualities, and the company could be better placed for growth than its larger peer Philip Morris.

Attractive qualities
Philip Morris' most attractive quality is its ownership of the famous Marlboro brand. British American lacks a similar iconic brand.

Nevertheless, the company has many attractive qualities. For example, the company's Global Drive Brands Dunhill, Kent, Pall Mall, and Lucky Strike are well known internationally and have been gaining market share over the past several years .

What's more, like Philip Morris, British American has a wide economic moat and geographical diversification. The company sells 75% of its cigarettes in developing markets. On the other hand, unlike Philip Morris, which for the most part relies on the sales of its high-price, high-margin Marlboro brand, British American's portfolio is roughly evenly divided among premium, mid-price, and low-price brands.

This gives the company a stronger long-term outlook than Philip Morris because as tobacco prices continue to rise, mainly due to higher excise taxes, British American is able to cover all bases.

Still, at present the international cigarette market continues to grow and British American will be able to profit from this.

Growing market
Over the period from 1990 to 2009, the volume of cigarettes consumed around the world increased from around 5,300 billion cigarettes to just under 6,000 billion, an increase of approximately 13% -- with the decline in consumption within developed markets like the US excluded, this figure would have been much higher .

Then there is also the issue of Reynolds American. You see, British American controls around 50% of Reynolds, and this gives the company exposure to the US cigarette market, something Philip Morris does not have.

British American has been forbidden from increasing its stake in Reynolds until this June, but it is possible that the Anglo-American company could swallow Reynolds to boost its margins. Analysts at Citigroup believe that this is a real possibility. Reynolds is a champion of the domestic cigarette market with an attractive electronic-cigarette segment, which would complement British American's existing offering and global presence.

However, Citi believes that a joint venture between Reynolds and British American is more probable than a takeover, as this would allow British American to access Reynolds' e-cig technology without having to jump over regulatory hurdles.

Citi believes that if British American does acquire Reynolds, the Anglo-American company would then make a swoop on Lorillard. Such a move would consolidate its position within the U.S. tobacco market and put it in a great position to take on industry behemoth Altria Group. Click here for "Your One-stop Guide to the Potential Reynolds American-Lorillard Merger".

Of course, if the much-debated deal between Lorillard and Reynolds goes ahead then a different outcome could arise altogether. In this case it is suspected that British American will take the parts of Reynolds that the larger Reynolds-Lorillard combination does not, or cannot, sustain. If you'd like more information on how British American could benefit from the Reynolds deal, I've written a summary which can be found here.

Foolish summary
So all in all, while Philip Morris has been the undisputed champion of the international tobacco market during the past few decades, British American is catching up. British American has a broad selection of tobacco brands and does not rely on one key brand to support sales. What's more, the company has access to the US domestic market unlike Philip Morris.

Nevertheless, like Philip Morris, British American has exposure to Asia, where cigarette sales are still rising. But overall, British American's product portfolio and global presence give the company a winning position in the market. It may be time for Philip Morris to step aside. 

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Rupert Hargreaves owns shares of Altria Group. The Motley Fool owns shares of Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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