Smoking: it's terrible for your health, but has been amazing for your nest egg. That's because even though the world knows all about the dangers of smoking, cigarettes are still a highly addictive product that costs very little -- comparatively -- to manufacture.
Today, we'll be settling the score between two of the world's largest tobacco companies: Philip Morris (NYSE: PM) and British American Tobacco (NYSE: BTI).
Image source: Getty Images
There's no way to know with 100% certainty which of these two will be the better performer over the next three to five years, but we can compare them on three crucial aspects of their business to see who comes out on top.
Sustainable competitive advantages
For long-term buy-and-hold investors, there's nothing more important to investigate than a company's sustainable competitive advantages. Professionals often refer to this as a "moat." The simple explanation is that a moat is anything that keeps customers coming back for more, year after year, while holding the competition at bay for decades.
Making cigarettes is relatively easy; there's little to stop someone new from entering the market and selling cigarettes for less. That's why the only real moat a company has is its brand value. Philip Morris International is the parent company for sales of Marlboro cigarettes outside of the United States, and Marlboro is by far the most valuable brand in the industry -- Forbes estimates that it is the 25th most valuable brand globally, worth over $24 billion. Statista also estimates that Philip Morris has the second highest market share in the world, at 14.6%, trailing only state-held China National Tobacco Corporation.
British American, on the other hand, recently bolstered its roster of valuable brands with the acquisition of Reynolds American. It now has global ownership of Newport, Camel, and Lucky Strike, among others. Statista estimates the combined entity's global market share at 12.6%.
Even though Philip Morris has the most valuable brand, the entirety of British American is close enough in market share -- a proxy for brand value -- that I'm calling this a draw.
Winner = Tie
Investors in tobacco are clearly in it for the reliable cash streams that support sizable dividends. While it might make sense to want all of the excess cash to be returned to shareholders, that's not in anyone's best interest over the long run.
That's because difficult economic times can pop up unexpectedly. Organizations with cash on hand can actually emerge stronger from those periods than they were before. They can buy back shares on the cheap, acquire rivals at a discount, or -- most devastating to the competition -- cut prices to take a loss over the short-run, while gaining market share for the next few decades.
Here's how these two stack up, keeping in mind that Philip Morris has a market cap about 57% higher than British American's.
|Cash||Debt||Net Income||Free Cash Flow|
|Philip Morris||$16 million||$20 billion||$10 billion||$10 billion|
|British American||$16 billion||$20 billion||$6 billion||$6 billion|
Data source: Yahoo! Finance, British American Tobacco IR. Figures rounded to nearest whole number. Net income and free cash flow presented on trailing twelve month basis.
Obviously, this is another very close competition. But there's an important caveat here. British American only releases results twice per year. The acquisition of Reynolds closed after July 1st, which means that the debt and share dilution associated with the transaction have yet to be factored in.
Winner = Philip Morris
|Company||P/E||P/FCF||Dividend Yield||FCF Payout Ratio|
Data source: Yahoo! Finance. N/A = Not applicable as company was not profitable over the past twelve months.
Unsurprisingly, we again have a very close competition. British American has a slightly higher dividend yield, and used less of its free cash flow to pay that dividend. Normally, that would be enough to give the nod to British American. But without updated numbers for what the company's financials look like post-Reynolds merger, I have to call this one a draw, too.
Winner = Tie
My winner is...
So there you have it: we essentially have a tie, but Philip Morris gets the nod because British American had to take on some extra debt and dilute shareholders to gain a stronger brand presence worldwide. Personally, I don't invest in tobacco, so I don't own either stock -- nor have I made a CAPS call on either -- but if you're a dividend investor looking for regular and reliable payouts, both of these companies are worth investigating.
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