No matter how uncomfortable Big Tobacco makes us feel, the cigarette companies are going to remain attractive stock buys. Share prices can vary, up or down, but these companies typically offer reliable rewards for investors, with steady income streams and positive cash flows.
Now that’s not to say the market won’t change. Alternative nicotine delivery systems, such as e-cig and heat-not-burn options, are going to define the future of these companies. Additionally, Big Tobacco sees a logical long-term partner in the emerging cannabis industry, which some industry analysts say can reach $66 billion by 2025. According to Altria CEO Howard Willard, a diverse portfolio will position his company to succeed as the tobacco landscape evolves away from traditional cigarettes.
A Union of Tobacco Giants
This junction of alternative nicotine and cannabis helps explain the rumors we have been hearing – now confirmed by both companies – about a ‘merger of equals’ agreement between Altria Group, Inc. (MO) and Philip Morris International, Inc. (PM). Early reports indicate the merger will be an all stock deal, giving PM 59% and MO 41% of the combined company. The split ratio simply reflects size of each company’s market cap.
A merger between these two tobacco companies will bring advantages to both. There is the obvious – combining customer bases, supply and distribution networks, marketing costs. More importantly, however, are the different paths they have each taken toward the alternative nicotine products that will shape the future of their industry.
Philip Morris has already invested some $6 billion dollars in the iQOS heated tobacco product, and has cultivated over 11 million users world-wide. For its own part, Altria has spent $12.8 billion building a 35% stake in the largest US e-cigarette company, JUUL. Altria also has a 45% stake, worth $1.8 billion, in Canada’s Cronos Group, Inc. (CRON), giving it a foot into the rapidly growing legal cannabis market. A PM-MO merger would help both companies with their fading cigarette business, but it also brings together a powerful combination of emerging tobacco and cannabis interests.
Altria Group, Inc. (MO)
Writing from Wells Fargo, 3-star analyst Bonnie Herzog sees both PM and MO as buying opportunities in light of their merger plans. Of Philip Morris, she notes that joining MO will improve the value of iQOS: “PM will capture the full margin and accelerate the growth of iQOS in the U.S. given its full control over sales and distribution.” She makes a similar point about Altria, saying that “MO is more attractive with its stake in JUUL, given JUUL’s clear dominance in the US e-cig/vapor market and international ambitions.” Herzog puts a $102 price target on PM shares, while declining to attach a specific target to her Buy rating on MO.
RBC Capital’s Nik Modi is less reticent, and puts a $68 target with his Buy on MO. He says the merger “makes strategic sense,” and says, “The combined entity would give BAT and Imperial products exposure to the U.S. markets and reduce FX headwinds for PM International, while giving Altria's JUUL more global exposure.” His target suggests a 55% upside to Altria.
Overall, MO holds a Moderate Buy from the analyst consensus, based on 5 recent buy ratings and 3 holds. Shares are selling for $43.74, and the average price target of $56.17 implies an upside potential of 28% for the stock.
Philip Morris International, Inc. (PM)
Christopher Growe, of Stifel, describes the Altria-Philip Morris merger as “game changing” for both companies. He says of the Philip Morris side, “Ultimately, this transaction would represent a bold vote of confidence in the potential in iQOS in the US.” He gives PM a solid Buy rating ahead of the final merger talks, but without a price target.
Philip Morris also holds a consensus rating of Moderate Buy, based on 8 buys, 1 hold, and 1 sell given in the last three months. The average price target, $97, suggests a solid 34% upside potential from the current share price of $72.
Cronos Group, Inc. (CRON)
Tobacco won’t be the only industry affected by an Altria-Philip Morris merger. As noted above, Altria brings to that table, among other assets, a 45% stake in Cronos Group, one of the larger players in Canada’s cannabis industry. We have noted before in this space some of the advantages that Altria’s investment opened up for Cronos: access for the Canadian company to Altria’s experience in processing and packaging smoking products, along with enhanced distribution networks. What’s equally important, however, is what Cronos brings to Altria: a new product, and a foot into a new market.
Looking at Cronos’ future, Piper Jaffray analyst Michael Lavery initiated coverage with a Buy rating and an $18 price target. He wrote, “We expect Cronos to have modest near-term revenues from Canadian cannabis production, but believe it has significant potential growth opportunities with CBD products in the US.” He adds that due to Altria’s investment in the company, CRON should have a “premium valuation;” the company has access to $1.8 billion in cash; to Altria’s 230,000 retail outlets in the US market; and to JUUL, where the application of vapor products to the emerging cannabis industry is clear. Lavery’s price target on CRON suggests an upside potential of 59% for the stock.
CRON is another Moderate Buy stock in the analyst consensus, based on 3 buys, 3 holds, and 1 sell. The current share price is $11.30, and the average price target of $17.63 implies an impressive upside of 56%. It’s worth noting here that even CRON’s low-estimate price target is higher than the current share price.
Canopy Growth Corporation (CGC)
We’ve been looking at so-called ‘sin’ stocks, which take their name, and profits, from the catalog of human foibles. The list won’t be complete, however, without Canopy Growth Corporation (CGC). Canopy is the largest of the Canadian cannabis companies – by market cap, by potential production, by sales – and like Cronos, it has the backing of a ‘sin’ giant. In Canopy’s case, the backer is Constellation Brands (STZ), the owner of Corona and Modelo beers, the largest beer importer to the US market.
Canopy’s former CEO, Bruce Linton, sought out Constellation’s backing as part of his vision for the company’s growth, and Constellation responded with a $4 billion investment, a 38% stake in the company, and control over Canopy’s Board of Directors. Constellation also fired Linton earlier this year, after Canopy reported two straight quarters of steep losses. Linton had a vision leading toward $1 billion annual revenues, but Constellation wasn’t willing to wait for a return on that sizable investment.
As a result, Canopy has been experiencing some turmoil. The company is seeking a new CEO, share prices are down by half this year, and yet… CGC remains a buy rated stock. As noted above, Canopy is backed by Constellation Brands. In addition, in the last quarter its cannabis production grew four-fold year-over-year and more than 12% sequentially, and the company has a market cap of $8.2 billion – by far the largest in the Cannabis industry.
Seaport Global analyst Brett Hundley sees a clear path to recovery for Canopy in the so-called ‘2.0 market’ in Canada’s cannabis industry. 2.0 refers to the coming legalization and development of additional cannabis products, including vapes, edibles, and beverages. Hundley writes, “In addition, the Canadian space is about to gain a fair amount of pricing power, in our view, as the 2.0 market opens up late this year. We think Canopy can regain some lost share of shelf, as it leverages R&D, IP and partnerships to bring leading value-added products to market.” As the cannabis market expands, Canopy’s connection with Constellation will become more valuable.
In light of CGC’s clear long-term strengths, Hundley rates the stock a buy and gives it a $31 price target. His target implies a 24% upside to the stock.
Canopy’s analyst consensus rating is a Moderate Buy, firmly based on 10 buys and 5 holds. The average price target of $39 implies an impressive 60% upside from the current share price of $24.
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