I'm Still Saying No to This Tobacco Stock

Buying into vice stocks is a touchy subject for some investors. Some choose to pass on them altogether, and as Foolish colleague Alyce Lomax has shown with her socially responsible Rising Stars portfolio, that move can actually be quite profitable.

Still, there are more than enough investors out there who rely on the steadfast addiction of consumers to tobacco and the somewhat steady stream of income that their habit provides shareholders in the form of a dividend. I am not willing to exclude vice stocks from my portfolio despite their obvious social detriments, but that doesn't stop me from once again coming down hard on one of America's favorite investments: Altria (NYS: MO) .

Blowing smoke
I've been pretty forthright about my dislike for Altria in the past, and I don't think its earnings report on Friday did anything to change my stance on the company.

With its operations based entirely in the United States, Altria falls under the scrutiny of one of the most stringent legal systems in the world. Its lack of diversification coupled with high unemployment rates and stiff competition yielded the company $0.01 in adjusted earnings beat in the fourth quarter, but net income still fell 9% over the year-ago period.

Altria admitted its core cigarette business is more or less stagnant. Its flagship Marlboro brand continues to lose market share, down another 70 basis points to 41.6%. With the average price of Marlboro cigarettes at $5.73, cheaper alternatives have been stealing market share with regularity of late. Maverick from Lorillard (NYS: LO) and Pall Mall from Reynolds American (NYS: RAI) have been the primary culprits, with prices, in some cases, a full 25% below Marlboro's average price point.

Smokeless or smoke less?
For the quarter, cigarette volumes were flat at 33.7 billion, with its discount brands picking up the Marlboro brand's slack. In fact, the only bright spot for Altria remains its discount brand names and its smokeless-tobacco line.

Altria currently controls 55.5% of the smokeless-tobacco market, and it grew sales in this division by 7% to $391 million. Don't get too excited, though -- this $391 million compares with the $5.3 billion in sales its cigarette division contributed and seems minuscule by all standards. In addition, despite the huge market share, it's not as if growing sales in this segment will be a cakewalk. Star Scientific (NAS: CIGX) is currently at work trying to develop a form of non-carcinogenic tobacco, while Reynolds American markets Kodiak, Grizzly, and Camel Snus. Nothing is going to be a walk in the park for Altria anymore.

The real Catch-22 here seems to be that Altria's discount brands are singlehandedly buoying its shipped cigarette volume and boosting its sales figures, but at the same time these discount brands offer a much lower margin and are crimping the company's bottom line. EPS growth from cost-cutting initiatives and layoffs is projected to be 6%-9% in 2012. Even if Altria hits these targets, it's still trading at the upper end of its price-to-book, price-to-sales, and price-to-cash-flow ratio over the past decade. In short, as growth slows, Altria just keeps getting pricier whether its stock moves higher or not.

Buy this instead
I continue to believe Philip Morris International (NYS: PM) is a much smarter alterative if you want tobacco represented in your portfolio. It offers a lower yield, but what it lacks in yield it will more than make up for with growth potential. Philip Morris offers worldwide portfolio of tobacco diversification and, as such, doesn't fall under the same stringent laws that Altria currently has to contend with. It has grown its gross margin every year since 2006 and boasts a nearly 12% better gross margin than Altria over the trailing 12 months (65.6% vs. 53.7%). Better margins means not having to work as hard to earn a profit, which is great for shareholders and the potential for Philip Morris' dividend to head higher.

What do you think: Is Altria huffing and puffing here, or does it have the potential to head higher? Share your thoughts in the comments section below, and consider adding Altria to your free and personalized watchlist so you can keep up with the latest news on the tobacco giant.

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At the time thisarticle was published Fool contributorSean Williamshas no material interest in any companies mentioned in this article. The only thing he smokes is his tires. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong. The Motley Fool owns shares of Altria and Philip Morris International.Motley Fool newsletter serviceshave recommended buying shares of Philip Morris International. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policythat isn't the butt of any jokes.

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