Thursday April 05, 2012
by Esther Kwon, Equity Analyst , S&P Capital IQ
S&P Capital IQ has a positive fundamental outlook for tobacco companies based mostly on their strong pricing power and substantial free cash flow generation.
After posting a nearly 30% surge in 2011, the S&P Tobacco Index has lagged the broader market in 2012, rising by 6.9% for the year to date through March 16 compared with the S&P 500’s 11.7% gain.
While we think last year’s performance will be difficult to match in 2012, we think tobacco stocks will still be attractive to investors as they move to return capital to shareholders through share repurchases and increased dividends.
We look for cigarette manufacturers to raise prices and cut costs in an effort to counter the effects of a 4% to 5% decline in unit consumption expected over the next few years.
Last year, industry volumes declined by approximately 3.5%, but performance varied among the manufacturers.
Philip Morris USA, a unit of Altria Group (MO), and R.J. Reynolds Tobacco Co., a unit of Reynolds American (RAI), posted volume declines of 4.0% and 5.1%, respectively.
Meanwhile, Lorillard (LO) and Philip Morris International (PM) grew volumes 6.9% and 1.7%, respectively.
Despite proposals to raise taxation on dividends, we think relatively high-yielding equities will be attractive to investors in a low yield environment.
As a group, our coverage universe of tobacco stocks yields an average of almost 5% compared to the 10-year treasury yield of just over 2%.
More importantly, every single one of the tobacco companies in our coverage raised its dividend in 2011 (Altria by 7.9%, Reynolds American 14.3%, Philip Morris International 12.5% and Lorillard 37.8%).
Tobacco companies executed billions of dollars in share repurchases in 2011, and we believe they are likely to continue this strong pace in 2012 and beyond.
Overall, we see these high-yielding stocks as attractive in a low interest rate environment.
Learn more about this financial newsletter at S&P The Outlook.