The following column is not going to provide you with the next Hansen Natural or a similar growth stock that is going to give you triple-digit returns over the next 12 months. It will, however, give you a stock that has punished the market over the past three years and displays few signs of any let-up in the near future. There are several reasons that Reynolds American (NYSE:RAI) has bestowed above-average returns upon its shareholders and will continue to do so.
From a fundamental standpoint, the stock's earnings and dividend history are two key factors behind its continued success. The company has a five-year average dividend yield of 5.6%, which is well above that of the S&P 500, which has consistently yielded less than 2%. Reynolds American announced last month that it will increase its quarterly dividend by 20%, which will help to maintain a dividend yield for its investors that is well above the market average.
In its second-quarter earnings release at the end of July, the company announced that its second-quarter profits rose by 50%. Pricing markups, increased productivity, and strong shipment volume enabled Reynolds to attain these numbers. However, it should be taken into account that these earnings are partially inflated by trade purchases that will adversely impact earnings in the second half of the year. Lynn J. Beasely, R.J. Reynolds' president and chief operating officer, noted, "Full-year shipment volumes should be down approximately 4%, consistent with consumption decline during the first half."
To offset the negative sentiment resulting from these expectations, the company has made several decisions recently that should make this security a profitable investment. One of them was its resolution to foray into smokeless tobacco via the acquisition of Conwood, the nation's second-largest smokeless tobacco manufacturer. The acquisition will benefit shareholders in the form of continued growth as the company expands the realm of its business. This acquisition, coupled with incremental tax gains, has allowed the company to revise upwards its forecasted EPS for fiscal year 2006, from its original forecast of $4.00-$4.20 per share to $4.15-$4.25 per share (split adjusted). Even the low end of this estimate would present the company with a 15% rise from the $3.53 EPS it realized in 2005.
Another significant step taken by Reynolds was the announcement of a two-for-one stock split. This move will make this security more accessible to individual investors and has been viewed as a positive signal by the market (although the stock split itself has no effect on the value of the company).
From a risk perspective, potential investors considering the purchase of tobacco stocks like Altria (NYSE:MO) and Carolina Group (NYSE:CG) often cite litigation surrounding the industry as an area of worry. While the litigation isn't going away anytime soon, shareholders can take solace from the Florida Supreme Court's decision last month to toss out a $145 billion punitive damage verdict against Big Tobacco. Another area of concern to Fools looking to buy into Reynolds might be the occurrence of anti-smoking measures that have been popping up across the nation. Reynolds is not going to take this fight sitting down either. It has pledged to spend $40 million to stomp out proposed smoking bans in Arizona and Ohio, as well as ballot initiatives aimed at raising cigarette taxes in California and Missouri.
As a shareholder myself, I honestly like this beast's upside potential at its current price of $64 just as much as when I purchased it 15 months ago at $40 (and again five months ago at $55). Management's aggressive approach in the areas of M&A and litigation, taken together with the brand's pricing power, will continue to make this stock a force to be reckoned with.
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Fool contributor Billy Fisher owns shares of Reynolds American.
