Jefferies On U.S. Tobacco: Prefers Reynolds American

While expressing optimism regarding the US tobacco sector, Jefferies’ Owen Bennett said in a report that the combined sector 12-month TSR is estimated at over 20 percent. He added that this could be the beginning of “a new era,” since industry value drivers were “fundamentally more favourable” than they have been in the past.

Bennett initiated coverage of Altria Group Inc MO with a Hold rating and a price target of $70 and of Reynolds American, Inc. RAI with a Buy rating and a price target of $61. Philip Morris International Inc. PM also received a Hold rating.

Related Link: U.S. Demand For Cigarettes The Strongest It's Been In Decades: Citi Initiates Tobacco Names

E-vapor Would Be A Significant Contributor

While regulators may impede innovation and growth in e-vapor over the next couple of years, the trends would likely accelerate from FY 2019, which is when heat-not-burn products are likely to get modified risk status, Bennett mentioned. He explained that this product more closely replicated the act and performance of smoking and would likely result in greater conversion.

The analyst expects combined vapor EBIT of Altria and Reynolds to reach close to $1 billion by 2020, versus an expected loss of around $300 million in FY 2016. He added, however, that Altria doesn't have its own heat-not-burn product and would be distributing Philip Morris International’s product.

“While valuations look expensive relative to the past, the fundamentals are now more favourable. Medium term growth outlook is much improved, litigation risk is diminishing, and we now have a growing vapour segment,” Bennett wrote.

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