EUR 850.00 For Business Accounts Only

Morningstar | Slightly Lowering Valuation in Tobacco, but We See Upside to the Group; IMB Our Pick

We are lowering our fair value estimates for three of our global large-cap tobacco manufacturers, after taking a less optimistic view of medium-term margins. Nevertheless, we still believe upside exists to the stocks, particularly Imperial Brands and Philip Morris International, and we think the group is heavily out of favor after heated tobacco sales suddenly plateaued in Japan in the first quarter of this year. The catalyst, however, may not come until early next year when PMI commercializes its disposable heated-tobacco product. The high cost of the devices may be keeping some consumers on the sidelines, and we expect the late adopters to be enticed by some of the pipeline products that the tobacco manufacturers will bring to market in the next two to three years.

Specifically, we are lowering our fair value estimates for British American Tobacco to GBX 4,500 from GBX 4,800, for Imperial Brands to GBX 3,700 from GBX 3,900, and for Philip Morris International to $102 from $104. We do not share the consensus view that tobacco margins will continue to expand over the next five years. While evidence from Japan suggests industry volumes may be little affected by the adoption of substitute products, we are concerned that negative mix from vapor and devices and continued operating deleverage from declining volumes will be headwinds for EBIT margins in the medium term. Further, we are concerned that the migration of smokers to substitute products will spread volume across multiple product platforms, which will erode Big Tobacco's cost advantage and further constrain margin expansion. We now assume relatively flat margins at roughly the 40% mark for all three companies, down from our previous assumption of margins rising gradually by around 2 percentage points over a five-year period.