Better Buy: Philip Morris International, Inc. vs. Reynolds American

Image source: Reynolds American.

Tobacco is a worldwide business, and Philip Morris International (PM -2.96%) and Reynolds American (RAI) serve different parts of the global market. Lately, Reynolds American has had more success serving the U.S. market than Philip Morris has had internationally, but the two stocks have both given investors good long-term returns. Investors who are looking at both stocks for the first time want to know which is the better buy right now. Let's compare Philip Morris International and Reynolds American on a number of metrics to see which one looks more attractive currently.

Valuation
In terms of stock returns, Reynolds American has done far better than Philip Morris International over the past year. Reynolds American's total one-year return weighs in at 38%, which is more than double the 16% return that Philip Morris has given its shareholders.

Even with Reynolds American's big gains over the past year, its valuation hasn't climbed appreciably above where Philip Morris currently trades. On a trailing basis, Reynolds American trades at between 19 and 20 times earnings, compared to almost 21 times earnings for Philip Morris. Investors have slightly higher growth expectations for Philip Morris, but on a forward basis, both stocks carry earnings multiples of around 19. Both companies look similar on a basic valuation basis.

Dividends
Both Reynolds American and Philip Morris International have given investors lucrative dividends in their histories. Philip Morris International pays a substantially higher yield of 4.4%, compared to Reynolds American's 3.3% dividend yield.

But a couple of things make the question more complicated for dividend investors. Philosophically, both companies have similar ideas in returning the bulk of their earnings to investors through dividends. Yet Reynolds American's earnings payout ratio has been substantially lower and currently is at about 60%. By contrast, Philip Morris earnings have been under pressure from adverse currency fluctuations, and that has pushed the company's payout ratio upward of 90%. That limited Philip Morris' ability to make a sizable dividend boost last year and could weigh on it again if the dollar keeps strengthening.

Both Reynolds American and Philip Morris have done a good job of growing their dividends over time. Reynolds American has boosted its payouts annually for about a decade, more than tripling its payout over that time frame. Philip Morris has been a separate company only since 2008, but it has more than doubled its dividends during that nearly eight-year stretch. Both stocks have compelling dividend attributes that make them roughly comparable to each other.

Growth
Growth is where these two companies really start to part ways. Reynolds American is in hyper-growth mode following its acquisition of Lorillard, which gave it access to the highly successful Newport brand. By contrast, Philip Morris International has had to deal with dollar-related headwinds that have crushed its growth at least temporarily.

For Philip Morris' most recent quarter, the company saw sales plunge 11%, and net income fell at double that rate. Revenue in its major segments was up in local-currency terms, though, and favorable pricing trends helped the company offset lower shipments of cigarettes systemwide. Yet the company still expects the strong dollar to be a problem in 2016, and it projected a decline in earnings per share compared to 2015 stemming from a nearly 15% currency hit on the bottom line. Adjusting for the dollar's strength, Philip Morris expects 10% to 12% growth in adjusted net income, but investors won't necessarily see that borne out in the final numbers.

Reynolds American has investors much happier about its future, although most of the gains in its financials came from the Lorillard acquisition. Revenue soared 43% and adjusted net income climbed by almost 50%, and the company has seen some traction from its Vuse line of e-vapor products. Moreover, its Natural American Spirit ultra-premium brand has had good success, and while it's a far stretch from the dominance that Philip Morris' Marlboro has shown, Reynolds has even more ability to take the Lorillard Newport brand and develop it into a colossus in the U.S. market.

Based on current conditions, Reynolds American gets a slight preference because of the currency troubles that Philip Morris is facing. When the dollar's strength finally gives way, the time might be right for Philip Morris to emerge from its funk and start outperforming Reynolds and other tobacco peers again.