Why Are Investors Undervaluing Altria?

Altria Group is by far the largest listed United States tobacco company. However, on valuation grounds, Altria is cheaper than its smaller peers Reynolds American and Lorillard (NYSE: LO). I believe this discount is not warranted, as sector leaders like Altria usually trade at a premium to their smaller peers due to their dominance in the industry.

Valuation
Before I get down to the nitty-gritty, here's is a quick overview of Altria's valuation in comparison to its domestic peers,Reynolds American andLorillard.

Source: FINVIZ.com

As the table shows, Altria is trading at a valuation below that of both its peers. Furthermore, Altria offers a larger dividend yield than its peers and is expected to report stronger earnings growth this year.

That being said, I should mention that although Atria's earnings per share are slated to rise 26% for full-year 2013, this figure has recently been downgraded by the company. This downgrade comes after the company took a $1.1 billion one-time pre-tax charge related to the financing of its debt.

Nevertheless, Altria is still expecting to report EPS growth of 7% to 9% for the full year after this charge. While this debt refinancing is short-term earnings negative, for the long term it should be earnings accretive as the company was able to drastically reduce the interest rate it paid on the debt.

Still, EPS growth of 7% to 9% for 2013 indicates that Altria will outperform its two smaller peers.

Diversification
So we can see that Altria is undervalued, despite being forecast to achieve similar earnings growth to its peers and offering a strong dividend yield.

What's more, Altria has much more diversification than both Lorillard and Reynolds. Indeed, during the recently reported fiscal third quarter, Altria's revenue came to a total of $6.5 billion before excise taxes. Of that, $5.8 billion, or 89%, was from "smokeable" products and $500 million was from smokeless products; around 8% of revenue. Meanwhile, wine contributed $150 million, or 2% of revenue.

While wine and smokeless products only contribute 10% to Altria's total revenue, they still offer some diversification away from the smoking side of the business. In addition, we should not forget Altria's 30% share of SABMiller, which is worth around $23 billion at current rates. This holding in SABMiller further boosts Altria's diversification away from tobacco.

In comparison, Lorillard's electronic-cigarette sales, the company's only diversification outside of the traditional cigarette market, only contributed 3.4% of total revenue pre-excise taxes. Reynolds American's snuff smokeless division only contributed 8% to overall revenue during the third quarter.

Death threats
In addition, there is one factor that is hanging over both Lorillard and Reynolds, which is unlikely to affect Altria, and that is the issue of menthol.

The majority of Lorillard's sales are from menthol products, while 30% of Reynolds' sales are in menthol. Back in July, the Food and Drug Administration released a preliminary scientific evaluation of the impact of menthol cigarettes on public health. The report concluded that 88% of adult smokers started smoking before they turned 18, and for most, the first cigarette they tried was menthol. In conclusion, the report noted that these results "make it likely that menthol cigarettes pose a public health risk above that seen with non-menthol cigarettes."

The European parliament has already taken the step to ban menthol cigarettes starting in 2022, and it is entirely possible that the FDA could follow a similar path. The agency sought public comment on the matter up until Nov. 22, and now the industry is waiting for a decision.

While a complete ban is unlikely, restrictions are going to hit the sales of Lorillard and Reynolds significantly. Altria, on the other hand, is unlikely to be significantly affected. This reason alone is enough to justify the fact that Altria should not trade at a discount to these two peers.

In conclusion
Overall, Altria's discount to its domestic peers is unwarranted. Altria offers a similar dividend yield to that of both its peers. Additionally, the company's earnings-per-share growth for this year is expected to be similar to peers once again. The company as has more diversification away from the tobacco industry, which without a doubt is in decline. So, based on that and the company's size, Altria defiantly deserves to trade at a higher premium than its peers.

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The article Why Are Investors Undervaluing Altria? originally appeared on Fool.com.

Fool contributor Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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