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

By Dan Caplinger - May 18, 2016 at 4:25PM

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Which tobacco stock should you consider right now?


Image source: Reynolds American.

Tobacco stocks have provided solid long-term returns for investors, and there are different ways to play the tobacco market. Philip Morris International (PM 0.99%) concentrates its efforts on the international realm, while Reynolds American (RAI) has focused its business domestically. Still, both have seen some similar challenges recently, and both have sought to capitalize on the growth opportunities in their respective markets.

For those looking to add a tobacco stock to their portfolio, which one is the better buy? Let's look at Philip Morris International and Reynolds American using a number of metrics to compare the two.

Valuation and stock performance

Both Philip Morris and Reynolds American have delivered strong returns recently, but Reynolds American is the clear winner between the two. Since May 2016, Reynolds American has given shareholders a 36% total return, compared to 22% for Philip Morris.

When you look at some simple valuation metrics, Reynolds American also ends up looking at first glance like it's the clear winner. Using trailing financials over the past year to value the stock, Reynolds American shares currently trade at just 10.5 times earnings. That makes Philip Morris look expensive with its trailing earnings multiple of 23.

However, Reynolds American's trailing results include substantial one-time items. On a forward basis, the valuation advantage shifts dramatically. Philip Morris still has a fairly high forward multiple of 20, but Reynolds weighs in at 19 times forward earnings, wiping out most of the difference between the two. Nevertheless, Reynolds American has a slight edge over Philip Morris in terms of valuation, and the domestic tobacco giant has definitely outperformed its international rival on total return.

Dividends

Both Reynolds American and Philip Morris International offer dividend investors big payouts. Currently, Philip Morris International has a dividend yield of more than 4%. That compares favorably to the 3.3% Reynolds American boasts right now.

However, there's another twist many will see as being beneficial to Reynolds American. Right now, Philip Morris is paying out 95% of its earnings in the form of dividends, and it has suspended buybacks of its stock in light of currency-based earnings headwinds. By contrast, Reynolds is paying out just 30% of its trailing earnings, and although those figures are temporarily inflated, even its forward-looking payout ratio is less.

Moreover, both Reynolds American and Philip Morris have produced long-term dividend growth. Reynolds American has tripled its quarterly dividend over the past decade and made annual increases to its dividend every year during that period. Since going public, Philip Morris has more than doubled its quarterly payouts. The countervailing considerations make both stocks good on the dividend front, albeit in different ways.

Growth and fundamentals

The big difference in the two companies comes in their fundamental performance and growth prospects. Philip Morris has struggled under currency issues, but Reynolds American has made the most of its Lorillard merger.

In its most recent quarter, Philip Morris International suffered an 8% drop in revenue, and that sent net income down by an even steeper 15%. Cigarette shipment volumes declined, and the company saw weaker results in all of its geographical regions. CEO Andre Calantzopoulos blamed part of the poor-looking performance on unusual strength in the year-earlier quarter, however, and the company raised its earnings guidance because of a more favorable outlook for the U.S. dollar. If currency impacts subside, investors hope Philip Morris can once again grow its bottom line at a healthy clip.

By contrast, Reynolds American is growing quickly. Adjusted earnings were up 16% from year-ago levels, and the company reaffirmed its guidance for the full 2016 year. The sale of Reynolds American's Natural American Spirit business outside the U.S. takes the company out of direct competition with Philip Morris on the ultra-premium cigarette front, and Reynolds American also boosted its dividend by a sixth. Investors were also pleased that CEO Susan Cameron will remain beyond her original departure date to oversee the full integration of Lorillard's Newport brand into the Reynolds American arsenal.

Currently, using these metrics, Reynolds American looks like the better buy between these two stocks. Philip Morris is in a position to bounce back in time, but investors won't see a full turnaround until foreign currencies start to gain some ground against the U.S. dollar.

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Stocks Mentioned

Philip Morris International Inc. Stock Quote
Philip Morris International Inc.
PM
$99.72 (0.99%) $0.98
Reynolds American Inc. Stock Quote
Reynolds American Inc.
RAI

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