Stock buybacks are generally considered a bullish signal on Wall Street. They return capital to shareholders, while declaring management's belief that its own cheap shares are its best return on investment. As long as profits remain consistent, share repurchases can even increase earnings per share, by dividing the same amount of earnings among a smaller pool of shares outstanding.
But don't forget -- a company isn't obligated to repurchase shares just because it announced its intention to do so. So don't use the announcement as a reason to buy by itself, rather use it as a launching pad for additional research.
Up in smoke
Tobacco giant Altria (NYSE:MO) saw profits tumble 44% as it recorded a $0.28-per-share charge from extinguishing high-cost borrowings and substituting in lower-cost debt. Backing out those charges, however, saw earnings match expectations of $0.58 a share, but that hasn't helped its stock, which has fallen 12% from the 52-week highs it hit back in August.
The cigarette maker has a $1 billion share repurchase program already in place with about $550 million remaining but expanded it by another $500 million, which it expects to complete by the end of the second quarter next year.
Although Altria realized an overall 1% rise in its revenues in the third quarter, it was more the result of volume increases in its discount brands than in its premium products. While its flagship Marlboro brand saw volumes rise 1%, it was the 14% increase in volumes by discount cigarette brands that lit up the 3% increase in revenues, excluding excise taxes. Altria's other premium brand volumes fell by about 8%.
Smoking out the competition
Marlboro's results allowed it to regain about 1% of its market share, giving it 42.7% of the U.S. market. Reynolds American (NYSE:RAI) and Lorillard (NYSE:LO), the No. 2 and No. 3 cigarette makers, both saw cigarette sales volumes fall 7% and 2%, respectively, even though price hikes allowed them to record higher quarterly profits.
While tough economic times and high taxes dictate discount cigarettes will remain popular with smokers, Marlboro proves it's able to keep consumers as well as attract new ones despite its higher per-pack price. A pack of Marlboros goes for $5.79, while Lorillard and Reynolds American discount smokes cost about a dollar less per pack on average. But Altria has been getting more aggressive in its pricing, forcing both of its rivals to take steps to counteract that, and that has analysts concerned it will create profit headwinds for the industry.
Philip Morris International (NYSE:PM) faces a different set of problems. Because of its global focus, it hasn't run into the same level of regressive attacks as U.S. cigarette companies, but the strong U.S. dollar has hit it hard in the pocketbook nonetheless, and third-quarter profits fell 6% from the year-ago period. The effects were magnified as shipment volumes fell 5% despite higher prices.
High cost of death
At 16 times earnings and 13 times estimates, Altria trades at valuations ahead of its U.S. counterparts, but not at such a premium that's unworthy of the industry leader. And though Phillip Morris and British American Tobacco (NYSE:BTI) have separate concerns, their valuations exceed those of domestic producers.
Altria still throws off lots of cash, generating more than $3 billion in free cash flow, but with its enterprise value trading north of 23 the FCF, it doesn't look cheap at these levels. In comparison, Lorrilard goes for 15 times its FCF, while Reynolds trades for 17 times.
Despite the high valuations, I rated Altria to outperform the broad market averages on Motley Fool CAPS, the 180,000 member-driven investor community that translates informed opinion into stock ratings of one to five stars. The top-rated cigarette maker has appreciated by 10% since I weighed in almost a year ago (it's given back some of its best gains), but the S&P 500 has gained almost 13%, meaning my score is the one that's underperforming here. But by making the CAPScall here, I hold myself accountable for the bullish sentiments expressed, and over the long haul, I think its shares will appreciate in value, so any buybacks it makes now will eventually be a good deal.
That's the spirit
Altria is fighting a war on several fronts, but let me know in the comments section below if you disagree with my view that the buyback announcement in this instance heralds good news, not a waste of time.
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Rich Duprey and The Motley Fool have no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.