Citi initiated tobacco companies Altria (MO) and Philip Morris (PM) (the international arm of Altria) at BUY. The bank gives a strong thesis for why concerns about slowing unit sales and litigation are overblown. Smokers are price insensitive, they say, and no matter how poor they get, they’ll continue to light up:
- P/E discount inappropriate now — The discount appears to reflect litigation concerns, and a view that industry is shrinking. We believe both are overplayed.
- Industry can grow despite declining volumes, as long as prices rise — Our years covering the international industry have taught us that tobacco companies grow revenues and widen margins since they can increase prices faster than volumes fall. In Italy (PMI’s largest mkt) prices (ex tax) have risen at 5% CAGR in the last 4 years, while volumes have fallen 2%. With sales up and costs down, profit increases.
- No sign the price mechanism is exhausted — In the UK, Marlboro retails at $11, and retail prices are still rising at 4% a year, in-line with wages, so affordability is constant. This implies US prices have plenty of room to increase.
- Litigation is no longer such a serious issue — MO has paid total damages of only $109m for tobacco litigation vs. $5bln annual EBIT. Few new cases are being filed as incentives to do so are now so low.
Citi initiates Altria Group (MO) with a Buy, target price $24.50.
Citi initiates Philip Morris (PM) with a Buy, target price $62.
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