Price Hikes May Light Up Tobacco Stocks

Declining cigarette sales and volumes continue to pressure large tobacco companies. Last month, Nielsen released its latest retail data, which showed that U.S. cigarette sales fell 6.9%, while volume slumped by 11.2% – the steepest reduction since 2015.

To combat falling tobacco demand, industry giant Altria Group, Inc. (MO) has raised its prices six cents per pack, or $3 per carton, according to Wells Fargo analyst Bonnie Herzog, per Barron's. The company last increased prices back in February; therefore, the latest hike comes sooner than the usual six months between price increases. Herzog argues that the move demonstrates Altria's pricing power, adding that British American Tobacco p.l.c. (BTI), along with other industry players, will likely follow with out-of-cycle price hikes in the near future.

In addition to increasing their prices, tobacco companies trade at a significant discount based on earnings and pay eye-watering high dividends that investors may appreciate more as the prospects of a rate cut grow. Moreover, these firms continue to up their investment in the lucrative e-cigarette market to diversify risk.

Let's take a look closer look at the industry's three heavyweights and discuss possible trading tactics.

Philip Morris International Inc. (PM)

New York-based Philip Morris International Inc. (PM) manufactures and markets cigarettes in addition to other nicotine-containing products and related electronic devices and accessories. Some of the $119.25 billion tobacco company's well-known brands include Marlboro, Parliament, Bond Street, Chesterfield, and Philip Morris. In April, the Food and Drug Administration (FDA) finally approved the company's vaping heat-not-burn iQOS device. The FDA's green light should help Philip Morris reclaim some of the thriving e-cigarette market share. From a valuation standpoint, the company trades at 15.5 times earnings compared to 18.9 times for the average S&P 500 component. Philip Morris stock offers an enticing dividend yield of almost 6% and has returned 16.52% year to date (YTD) as of June 20, 2019.

The cigarette maker's stock shot up over 40% between late December and March. Since that time, the price has oscillated within an orderly descending channel that has established well-defined support and resistance zones. The current pullback to the channel's lower trendline provides traders with a suitable entry point to go long. Those who take a position should book profits on a move to the channel pattern's upper trendline at the $84 level. Cut losses if the stock fails to hold the $75 level.

Altria Group, Inc. (MO)

Founded 100 years ago, Altria Group manufactures and sells cigarettes, smokeless products, and wine in the United States. The company sells its tobacco products primarily to wholesalers, distributors, and large retail chains. Altria has taken proactive steps toward a cigarette-free future through its sizeable investments in vaping maker Juul Labs, pouch product on!, and cannabis player Cronos Group Inc. (CRON). Analysts have a 12-month average price target on the stock at $58.73 – a 17.7% premium from Wednesday's $49.90 closing price. As of June 20, 2019, Altria shares issue a 6.38% dividend yield, have a price-to-earnings ratio (P/E ratio) of 15.2, and are trading up just 4.27% YTD, underperforming the tobacco industry average and the S&P 500 by 7.62% and 12.47%, respectively.

Altria shares rallied above the 200-day simple moving average (SMA) in March but have since trended steadily lower. Like Phillip Morris, the stock has traded within a descending channel as it has fallen. After initially breaking above the pattern's top trendline earlier this month, the price has retraced to the breakout point, which now acts as support. Traders may want to wait for a price reversal, such as a hammer or bullish engulfing pattern, before entering. Once in a position, consider setting a take-profit order near the early-April swing high at the $57 level. Set a stop beneath last month's low at $47.94.

British American Tobacco p.l.c. (BTI)

British American Tobacco provides cigarettes and other tobacco products globally. Its primary offerings include vapor and tobacco heating products along with oral tobacco and nicotine products, such as tobacco-free nicotine pouches, cigars, and e-cigarettes. Despite the headwinds buffeting its traditional tobacco business, British American has kept gross margins above 70% over the past decade, demonstrating prudent management. The company recently reiterated its 2019 full-year revenue growth guidance in the mid to upper half of its 3% to 5% target range. It also expects to deliver between 30% and 50% revenue growth in alternative smoking products over the period.

The maker of Lucky Strike and Dunhill cigarettes trades at a significant discount to other industry players with a P/E ratio of just 10.7 compared to 15.5 for the average tobacco company. British American Tobacco stock has a market capitalization of $84.48 billion, yields a whopping 7.78%, and is up 13.45% YTD as of June 20, 2019.

The stock pared a large portion of its steep fourth quarter loss in the first three months of this year but found significant resistance at the 200-day SMA. More recently, the stock has retraced toward the $34.50 level, where the price finds support from a horizontal line connecting a series of prices over the past six months. Traders who enter at this level should look for the price to reclose the Nov. 12 gap at around $40. Think about setting a stop-loss order below $34 to limit downside risk.