Tobacco Stocks in Play After Abandoned Altria/Philip Morris Merger

A colossal merger between two of the tobacco industry's most prominent companies – Philip Morris International Inc. (PM) and Altria Group, Inc. (MO) – is up in smoke. Less than a month after the proposed union was put forward by both firms, Philip Morris announced Wednesday that it had ended the $187 billion merger talks and instead will focus on launching the IQOS device – a heat-not-burn tobacco product approved by the Food and Drug Administration (FDA) – as part of its mutual interest with Altria to achieve a smoke-free future.

According to Reuters, a source familiar with the negotiations said Philip Morris got cold feet on the deal as regulatory pressure mounted on vaping device maker Juul Labs, a company in which Altria owns a 35% stake. The Trump administration recently proposed a ban on all flavored e-cigarettes, which represent 80% of Juul's sales, after a spike in their use by teenagers over the past two years. Phillip Morris also faced growing discontent from shareholders who remained skeptical about what benefits the tie-up of the two tobacco firms would bring.

News of the failed merger coincides with Juul CEO Kevin Burns stepping down to make way for K.C. Crosthwaite, who is leaving his role as chief strategy and growth officer at Altria. Installing an experienced tobacco veteran to head the e-cigarette company may indicate Juul's intention to work with regulators.

From a technical standpoint, the stock prices of Philip Morris and Altria, along with that of London-based British American Tobacco p.l.c. (BTI), sit at crucial support levels and appear poised to continue yesterday's industry relief rally. Let's review each issue in further detail and smoke out some possible trading plays.

Philip Morris International Inc. (PM)

Philip Morris manufactures and sells cigarettes and other nicotine-containing products, along with related electronic devices and accessories. The company behind iconic cigarette brands such as Marlboro and Chesterfield reported adjusted earnings of $1.46 per share in the second quarter on sales on $7.7 billion. Both figures exceeded Wall Street's expectations to register robust year-over-year respective growth of 8.5% and 5.4% on a constant-currency basis. After the upbeat earnings report, Barclays analyst Guarav Jain upgraded Philip Morris from equal weight to overweight and raised his price target from $82 to $100. Jain cited the company's revised revenue growth guidance of 6% for the change. Trading at $75.28 with a market capitalization of $117.12 billion and offering a 6.54% dividend yield, the stock has returned 12.36% year to date (YTD), outperforming the tobacco industry average by 8.43% as of Sept. 26, 2019.

Philip Morris shares have oscillated within a $14 descending channel since early June. News of the failed merger with Altria pushed the stock's price up over 5% on heavy volume from the pattern's lower trendline – a move that may result in a near-term test of the channel's top trendline at $84. Traders who want to position for follow-through buying to this level should place a stop-loss order just below $74 to protect against a sudden reversal in price. The trade offers an attractive risk/reward ratio of almost 1:7, assuming an execution at yesterday's closing price ($8.70 profit per share vs. $1.30 risk per share).

Altria Group, Inc. (MO)

Richmond, Virginia-based Altria Group sells cigarettes, smokeless products, and wine in the United States. The 100-year-old tobacco giant's bottom line grew 8.9% compared to the year-ago quarter, boosted by increased income from the company's smokeable and smokeless products segments, along with higher adjusted earnings from Altria's equity investment in brewing titan Anheuser-Busch InBev SA/NV (BUD). Analysts have a 12-month price target on the stock at $54.71, implying 35% upside from Wednesday's $40.56 close. As of Sept. 26, 2019, Altria shares have a market value of $75.78 billion, yield an eye-watering 8.25%, and are trading down roughly 13% on the year.

The cigarette maker's share price trended sharply higher between late January and March but has since remained confined in a narrow descending channel. Currently, the stock appears to be finding support at the $40 level near the pattern's bottom trendline and the January swing low. Before taking a long position, traders may wait for the moving average convergence divergence (MACD) line to cross above its signal line for added confirmation. Those who do take a trade should consider setting a take-profit order between $45 and $46, where the price encounters resistance from the 50-day simple moving average (SMA) and the channel's upper trendline. Limit downside by setting stops beneath the September low at $39.30.

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

British American Tobacco sells traditional tobacco and nicotine products as well as vapor e-cigarettes, including its Vype brand, heated tobacco, with Glo. Well-known brands in the company's portfolio include Dunhill, Camel, and Benson & Hedges. The $83.22 billion tobacco giant, which saw its top line grow 4.1% in the first half of 2019, announced earlier this month that it plans to cut 2,300 jobs globally, or a little over 4% of its workforce, by January as its new CEO Jack Bowles seeks to drive revenues in controversial e-cigarettes. As of Sept. 26, 2019, British American Tobacco stock sports the best YTD performance of the three companies discussed, returning 18.03%, and it also pays an enticing 7.43% dividend yield.

Since setting a 2019 high just above $41 in March, the company's shares have traded within a broad ascending triangle, with neither the bulls nor bears able to wrestle control of price action. In a more positive move, the stock rocketed 3% higher Wednesday after the abandoned merger story hit newswires, closing above the 200-day SMA and a short-term trendline situated within the triangle pattern. Those who want to buy here should think about setting a profit target near the previously mentioned YTD high and cutting losses if the price closes beneath the Sept. 24 low at $35.23. Manage risk by amending stop orders to the breakeven point if the stock moves above the triangle's upper trendline at $38.