What are we looking for?
Reports surfaced this week that the U.S. Federal Trade Commission is set to approve the $27-billion (U.S.) merger between cigarette manufacturers Reynolds American Inc. and Lorillard.
In the past, not owning tobacco stocks has been hazardous to your portfolio as the five tobacco companies that are included in the S&P 1500 are up about 189 per cent over the past decade, easily blowing away the S&P 500's approximately 76-per-cent gain.
The industry has long been a no-go zone for socially responsible investment funds and many retail investors – but for others, my colleague Rob Belanger and I thought we would have a look at tobacco stocks this week.
The screen
We started with global tobacco companies larger than $1-billion in market capitalization and sorted them from the largest to the smallest.
The EV/EBITDA (enterprise value divided by earnings before interest, taxes, depreciation and amortization) is one of the most commonly used valuation metrics. We are looking for a low number.
Price-to-sales is a valuation ratio that compares the company's stock price to its revenues. A low ratio may indicate the stock is undervalued.
The P/FCF ratio (price to free cash flow) is also a valuation metric – this one comparing the market price with the annual free cash flow. It represents the amount an investor is willing to pay for a dollar generated from a company's operations. A low number is preferred.
Sales growth during the past 12 months had to be positive.
Net profit margin measures how much the company actually keeps out of every dollar of sales, and only companies with profit margins over 10 per cent are shown.
The net debt/EBITDA is a measurement of leverage that shows how many years it would take a company to pay back its debt if its net debt and EBITDA are held constant. Only companies showing net debt/EBITDA of less than two times are shown. The ratio can be negative if the company has more cash than debt.
What did we find?
Only three companies outperformed the averages in five of the six categories. Eastern Tobacco is an Egyptian company producing cigarettes from imported tobacco. KT&G Corp., formerly known as Korea Tobacco and Ginseng, enjoys 70 per cent market share in South Korea and 20 per cent of sales are to foreign countries. Japan Tobacco Inc., based in Geneva, was formed in 1999 with the purchase of the non-U.S. assets of R.J. Reynolds.
Please consult an investment professional or conduct further research before buying any of the companies listed here.
Michael Bowman is a portfolio manager at Hamilton-based Wickham Investment Counsel Inc., an adviser to high-net-worth clients.