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Deserving of a Bigger Valuation

Cigarette manufacturer Reynolds American (RAI) has been rising quietly. The maker of Pall Mall  and Camel opened the year at $32 and is $44 today, good for a 27% gain — plus dividends. There’s quite a few positives the company has going for it now, first being this Sumer’s acquisition of Lorillard, makers of Newport, the nation’s number one menthol brand. The two companies morphing into one will slash costs, and create more profits. Altria and Reynolds now control 80% of the $100 billion U.S. tobacco market.

But the good news here is more than just the merger.  Its Natural American Spirit is the nation’s top selling super-premium brand and had volume growth of 25% last qtr. “The strength of Natural American Spirit is rooted in the appeal of its distinctive additive-free natural tobacco styles, including styles made with organic tobacco, and the brand is benefiting from initiatives to broaden awareness and trial.”from RAI’s 2015 Q2 earnings report.

The American Snuff division, which flagship’s brand is Grizzly, had a 18% increase in profits last qtr due to higher pricing and a 3% increase in volume. And E-cigarettes are giving the company growth opportunity in a new growing field. Reynold’s Vise brand delivers nicotine via inhaled vapor, and started selling nationwide last year.

Ten Year Chart

RAI_2015_Q3_10yr

Tobacco stocks are often overlooked. As of September 18th (when these charts were made) this stock’s gone from $10 to $42 in ten years, also payed $9 in dividends, for a total return of 400% for its shareholders.

RAI is now kicking profit growth up a notch. After having 7% growth in 2014 and 2014, the company is now expected to grow profits 16% this year and 15% next year. The estimated long-term growth rate is 14%.

Profit History

RAI_2015_Q3_PH

RAI stock has gotten more appreciation from investors recently. For much of the past decade the company had a P/E in the mid-teens. Now the stock’s got a P/E of 21. And really it’s deserving. Mid-teens profit growth plus a current yield of 3.3% gives RAI an estimated total return close to 20%. I feel a P/E of 22 is very deserving. RAI has increased its dividend each year since the company was formed in 2004, and gets a good safety rating of 2 rating from Value Line.

Sharek’s Take

Reynolds American is a solid selection for investors in the Conservative Growth Portfolio. This is a tobacco giant with a  high certainty as smokers don’t quit easily. The best thing the company has going for it is the stock is timely in a year where stock market gains are hard to come by. RAI is set to grow profits around 16% the next year-and-a-half and keeps beating the estimates by a little each qtr. Tack on a dividend north of 3% and this stock could give investors 20% total returns. This is a solid selection at 21 times earnings.

View the One Year Chart here.
View the Earnings Table here.

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