U.S. Demand For Cigarettes The Strongest It's Been In Decades: Citi Initiates Tobacco Names
U.S. demand for cigarettes is currently the strongest it has been for decades, and is likely to remain robust, Citi’s Adam Spielman said in a report. He added that Treasury yields are expected to remain low compared to the 4 percent dividend yields on tobacco stocks. Moreover, EPS growth is estimated at 8-9 percent.
Sales growth of U.S. cigarettes has outpaced that of food, HPC or CSDs, according to Nielsen. Spielman expects sales growth to remain strong over the next couple of years, with the migration into dip and e-vapor likely to remain subdued, partly due to FDA regulation of e-vapor products.
Domestic Vs. International Stocks
Spielman mentioned that domestic tobacco stocks are more attractive than international ones, recommending Altria Group Inc (NYSE: MO) and Reynolds American, Inc. (NYSE: RAI) over Philip Morris International Inc. (NYSE: PM). He cited the following reasons for believing that domestic stocks deserve a higher multiple:
- More predictable, with no FX volatility
- Sales growth is stronger when adjusted for inflation
- Taxation and regulation are more benign
- Risk from next-gen nicotine products is higher outside the US
- Litigation could be a negative surprise in Canada
Reynolds American Preferred
“Reynolds is our preferred name,” the analyst wrote. He pointed out that although the investment thesis and valuations of Reynolds American and Altria were similar, the former was expected to generate better sales and earnings growth, driven by faster market share gains and better mix, both within cigarettes and dip.
Spielman projected Reynolds American’s mid-term sales and EPS growth at 4 percent and 9 percent, respectively, both of which are a point better than the estimates for Altria.
The analyst initiated coverage of both companies with Buy ratings, with a price target of $57 for Reynolds American and of $72 for Altria.
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