Smoking Hot Or A "Sin"sational Investment?

By ANDREW BARY

NOW THAT CIGARETTE COMPANIES have gained the upper hand in their U.S. legal battles, Altria, the parent of Philip Morris, is setting free its giant overseas tobacco division, Philip Morris International. The long-awaited spin off, which occurred Friday, is a bullish development for investors in both companies, particularly the new Altria, which has room to cut costs and raise profit margins.

For the past two weeks, new Altria and Philip Morris International have been trading on a "when-issued" basis. They will begin regular trading today on the New York Stock Exchange. Altria investors will get one share of Philip Morris International for each Altria share, and "old Altria," which ended Friday at 74, will disappear. New Altria, which will keep the MO ticker, closed Friday at about 22; Philip Morris International finished at 52.

Nik Modi, a tobacco analyst at UBS, recently rated Altria a Buy and set a $30 price target. He argued Altria will best its main U.S. peers, Reynolds American (RAI) and Carolina Group (CG), with impressive 13% compound growth in earnings per share in the next three years. Carolina is the tracking stock for Lorillard, maker of Newport cigarettes.
Modi's growth target exceeds Altria's guidance of a 9% to 11% increase in 2008 earnings per share, and 8% to 10% annual growth starting in '09. He believes Altria can do better through a combination of price increases, cost reductions and stock buybacks. He notes that tobacco investors like cost-cutting stories, citing the strong showing in recent years of Reynolds American, the No. 2 U.S. cigarette producer with such brands as Camel, Winston and Salem.
Facing limited growth opportunities in the U.S., where cigarette consumption is declining at a 3% to 4% annual rate, new Altria is apt to focus on returning cash to shareholders through dividends and stock buybacks. Altria aims to pay out 75% of its earnings in dividends.

Both Altria and Philip Morris International will have strong balance sheets, with modest debt and huge annual cash flow. New Altria's stake in SABMiller, now worth $9 billion, or more than $4 per Altria share, could be monetized in coming years. The company will pay a hefty $1.16 a share in annual dividends, and aims to buy back $7.5 billion of stock in the next two years. New Altria also has an ambitious cost-reduction program that already has yielded $300 million in annual savings and could deliver another $700 million by 2010.

Altria has a dividend yield of 5.3% and a 2008 forward P/E of 13.3. Phillip Morris has a dividend yield of 3.5% and a 2008 forward P/E of 16.4. If you don't mind investing in "sin" this might be a pretty good investment.