Buy Altria and British American Tobacco

GuruFocus.com

- By Alberto Abaterusso

As a reaction to the proposed plan of the U.S. Food and Drug Administration to ban menthol cigarettes Thursday, shares of sellers collapsed on the stock market.

Altria Group Inc. (MO) declined 10% to $57.28 per share, and British American Tobacco PLC (BTI) plummeted 16% to $35.18 per share for the last five days through Nov. 15, as the rumor of a possible ban emerged on Nov. 9.


The market fears that such a proposal may significantly curb the profitability of these two tobacco giants since the sale of menthol cigarettes represents a huge stake of the total sales volume of cigarettes at Altria Group and British American Tobacco.

Last week, Vivien Azer, analyst at Cowen, said that the sale of menthol cigarettes represented 55% to the total U.S. sales volume of British American Tobacco and approximately 20% to the total sales volume of Altria Group in fiscal 2017.

From my view, a possible ban on menthol cigarettes will not have any impact on the sale and profitability of Altria Group and British American Tobacco, provided that a ban really enter into force.

I am convinced that the erasure of menthol cigarettes will be compensated for by an increase in the consumption of traditional cigarettes. The reason is very simple to grasp. The consumption of menthol cigarettes responds to a desire to satisfy a specific taste, while smoking is a behavior that in almost all cases becomes an addiction.

When menthol cigarettes entered the market, producers thought that a specific desire of a niche of smokers could never be satisfied without a strong habit of tobacco consumption well-established in the general population already for centuries.

It works thi way with many other products people have become addicted or drawn to over time. For example: If suddenly the sale of sparkling lemon water beer were forbidden, would people stop drinking beer? If one day worldwide health authorities decided that some colored inks could no longer be used, would people stop getting tattoos all of a sudden?

If a ban were put on the use of specifical social media, where internet users love to post selfies, do you really think that people would not increase the use of other social media to continue posting photos? Of course they would, and people could even become more addicted to social networks in that way.

Therefore, shareholders of these two tobacco giants should not be worried about the eventual ban on menthols, if it really happens. However, I do not think that a ban will be enacted.

But one thing is certain: The rumors have created a more compelling entry point in both tobacco giants, Altria Group Inc. and British American Tobacco PLC.

Investors cannot miss this incredible opportunity that the market is now making with these two loyal dividend payers.

Altria Group is granting its shareholders a forward dividend yield of 5.41% and British American Tobacco a forward dividend yield of 7.44% versus an industry median of 5%. The S&P 500 index has a dividend yield of 1.92% as of Nov. 15.

For the 52 weeks through Thursday, Altria Group declined 14% to a market capitalization of $111.05 billion and British American Tobacco decreased 47% to a market capitalization of $84.11 billion.

Altria Group has a price-book ratio of 6.95, a price-sales ratio of 4.28, a price-earnings ratio of 10.21 and a forward price-earnings ratio of 13.59.

British American Tobacco has a price-book ratio of 0.99, a price-sales ratio of 2.84, a price-earnings ratio of 1.52 and a forward price-earnings ratio of 8.94.

The industry has medians of 3.78 for the price-book ratio, 2.66 for the price-sales ratio, 17.38 for the price-earnings ratio and of 17.48 for the forward price-earnings ratio.

Altria Group has a recommendation rating of 2.2 out of 5 and an average target price of $67.62 versus a market value of $57.28 per share at close Thursday.

British American Tobacco has a recommendation rating of 1.7 out of 5 and an average target price of $53.86 versus a market value of $35.18 per share at close Thursday.

Disclosure: I have no positions in any securities mentioned.

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This article first appeared on GuruFocus.