Altria (NYSE:MO) and Philip Morris International (NYSE:PM) are tobacco stocks with robust dividends and the ability to weather recessions. While they face a number of challenges, including pressure from regulators and an ongoing secular decline in tobacco use, they are trading at what some investors may consider appealing valuations. Recently, Citi analyst Adam Spielman became more bullish on the tobacco sector, as he sees a decreased threat that vaping will disrupt the traditional cigarette market.
Altria spun off Philip Morris International in 2008, but the two companies still share the iconic Marlboro brand. However, Philip Morris International's tobacco revenues come from foreign markets, while Altria operates only domestically.
But which of those businesses looks like a better investment today?
The situation at Altria
Altria's recently reported third-quarter results showed again that it has pricing power in the market, as it continued to use price hikes to power its growth. Sales volumes for traditional tobacco products continue to decline in the U.S.
It expects to grow earnings modestly based on those price hikes, and through diversification into other product categories. Management expects earnings to grow at an annualized rate of 5% to 8% from 2020 to 2022. While tobacco product volumes are projected to continue their decline in the U.S. as smoking wanes, demand will likely stabilize at some point. Altria should also benefit from the FDA's recent shift away from tighter restrictions on the amount of nicotine in cigarettes sold in the U.S.
The company has also invested strategically to diversify itself beyond tobacco. Altria owns a 10% stake in AB InBev (NYSE:BUD), the mega brewer with 28% of the global beer market, and a 45% stake in cannabis company Cronos Group (NASDAQ:CRON). During Q3, the tobacco behemoth took a $4.5 billion writedown on its 35% stake in electronic cigarette company Juul Labs.
Altria recently began selling the IQOS, a heat-not-burn tobacco product that it claims is less unhealthy than traditional cigarettes. About 8.8 million people outside of the U.S. have already begun using the IQOS, according to Philip Morris International, with whom Altria has a licensing agreement. The Food and Drug Administration authorized the sale of IQOS products in the U.S. in 2019, but hasn't actually approved them. Nor has it called them safe, and the companies are not allowed to market IQOS with claims of reduced health risks.
The situation at Philip Morris International
Philip Morris International reported strong Q3 earnings in October, boosted by pricing increases and market share gains. These factors helped offset a 1.4% shipment volume decline. Management forecasts annual earnings-per-share growth of at least 8% through 2021. The company also spoke of the success of its reduced-risk tobacco products like IQOS, and the HTUs (heated tobacco units) it consumes.
"Our HTU in-market sales volume increased by 28.3%, driven by [European Union] and Eastern Europe regions," said CFO Martin King during the Q3 earnings call.
One major risk for IQOS and its HTUs, which the company hopes will eventually earn FDA classification as modified risk products, is that they could get lumped together with vaping products. Modified risk products now account for more than 17% of Philip Morris' total net revenue. IQOS, a major part of that portfolio, saw unit volumes increase 85% year over year in the third quarter. Vaping products -- which use nicotine-containing liquids, not actual tobacco -- have been associated with 52 deaths and 2,400 cases of lung injury, according to the CDC. Now many countries, including the U.S., are moving toward banning or heavily taxing vaping products.
In some countries, IQOS products are already subject to stringent government regulation along with vaping products. This fall, the Indian government banned the sale of both e-cigarettes and heat-not-burn devices.
Altria is trading at just 11.5 times next year's expected earnings, while Philip Morris trades at a forward P/E of 15.5. In early December, Citi's Spielman upgraded Altria to buy and downgraded Philip Morris to neutral, citing their relative valuations and his more bullish stance on traditional tobacco.
"These companies last traded on their current P/Es in the late 1990s and early 2000s, when investors thought that litigation might lead to bankruptcy," wrote Spielman.
While both consumer staple giants will be affected by ongoing regulatory scrutiny of their products and declines in cigarette smoking, Altria's valuation, dominance in the U.S. tobacco space, and strategic investments give it a slight edge, particularly with U.S. regulators relaxing their stance on nicotine reduction.