uploads///Q Valuation

Exploring Tobacco Companies’ Valuation Drivers

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Jul. 11 2016, Updated 11:07 a.m. ET

Relative valuation

Tobacco companies are trading at higher valuations compared to the S&P 500 Index (SPY) (IVV) (VOO) and the Dow Jones Industrial Average (DIA). Philip Morris International (PM) and Reynolds American (RAI) are trading at forward PE (price-to-earnings) multiples of 22.1x and 22.0x, respectively.

In comparison, the S&P 500 Index and the Dow Jones Industrial Average are trading at forward PE multiples of 17.8x and 16.7x, respectively. All valuations are as of July 6, 2016.

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Despite adverse foreign currency impacts faced by Philip Morris in 1Q16, its valuation has risen exceptionally by 29.3% compared to the start of 2015. This rise has primarily been due to reduced gaps following price increases, leading adult smokers to upgrade to Marlboro and Fortune. Marlboro’s shipment volume increased by 1.4% in 1Q16, reflecting growth in Italy, Spain, Korea, and Mexico.

RAI’s stock price has spiked by 48.9% since June 12, 2015, when it completed the acquisition of Lorillard. RAI’s 1Q16 reported earnings rose by 591.7% to $2.5 billion and reported a 72.4% rise in adjusted operating income to $0.72 billion. As a result, its valuation has risen by 25.3% compared to the start of 2015.

Other companies

Altria Group’s (MO) valuation has also risen by ~25% to 22.4x compared to the start of 2015, majorly due to its SABMiller transaction.

British American Tobacco (BTI) and Japan Tobacco (JAPAY) (JAPAF) are also trading at higher forward PE multiples of 21.0x and 17.6x, respectively, compared to the S&P 500 Index.

Developing economies

As the industry struggles with falling smoking rates, higher sales taxes, and strict regulations in mature markets, developing economies have offered relatively better prospects.

Following Brexit, tobacco companies will also face import barriers which could push UK-based tobacco retailers to source more locally. Growing populations and rising disposable incomes in emerging markets act as top-down growth catalysts for this industry.

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