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Wells Fargo's Tobacco Picks Ahead Of Earnings -- Barron's Blog
DOW JONES & COMPANY, INC. 10:19 AM ET 7/17/2017
Symbol Last Price Change
WFC 54.86 -0.13 (-0.24%)
PM 119.02 -0.11 (-0.09%)
MO 73.38 -0.55 (-0.74%)
QUOTES AS OF 02:42:28 PM ET 07/17/2017
Wells Fargo's (WFC) Bonnie Herzog and team have a preview out of tobacco earnings Monday

Herzog has an Overweight rating on Philip Morris(PM) ( PM) and Altria(MO) ( MO), and a Market Perform rating on Reynolds America ( RAI).

Philip Morris (PM) is her top pick in the sector, and she expects a good quarter ahead. From her note:

We reiterate our bullish call on PM ahead of its Q2 results on 7/20 as we expect strong iQOS performance & resilience in key combustible cig markets (e.g., France, Germany) to outweigh residual pressures from Tobacco Products Directive (TPD) related inventory shifts & challenging 1H comps in other conventional cig markets (e.g., Argentina, Italy, Spain, Turkey). We see further improvements in 2H17 as 1H comp/inventory challenges recede and price/mix & profitability improves as PM continues to shed low margin volume in favor of a more premium-positioned portfolio. We expect PM to report solid Q2 EPS of $1.23 (+10.3% FX-neutral growth) and expect a positive/upbeat tone from mgmt on the call. As such, we think there's a decent chance that mgmt raises its FY17 FX-neutral EPS growth guidance from 9-12% to 10-12% given increased visibility and momentum behind iQOS as well as improvements in key comb. cig markets.

As for Altria(MO) and Reynolds, she lowered her second-quarter EP estimates for both stocks, and she expects both were pressured by the California tax increases and lower priced brands. She thinks Altria(MO) could be at risk going into the earnings, but her long-term bull thesis means she recommends buying on any weakness.

More from her note:

Q2 expectations include: (1) topline growth of +1.7%/+2.8% for MO/RAI; (2) cig vol to decline -3.9% for MO and -3.4% for RAI (incl +0.9% Newport); (3) solid net price realization of +5.7%/+4.9% for MO/RAI; (4) smokeless volume of -2.8%/+ 2.3% MO/RAI; and (5) op margin expansion of +290bps/+255bps for MO/RAI. Due to n.t. pressure on Marlboro vol/share largely related to CA's $2/pk excise tax increase & lower priced brands as well as lingering neg impacts from its USSTC recall, we expect MO to maintain its 7.5%-9.5% adj. diluted FY17 EPS growth guidance (and not raise the midpoint by 50bps as it has in every Q2 over the last 5 years). We expect MO to take a cautious approach to full year expectations while it continues to execute its l.t. strategy to maximize core tobacco profitability & modest share gains. For the industry, we expect cig vol to decline 3.8% in FY17 reflecting the full impact of CA's cig tax increase with strong price realization (+5- 6%) to largely offset vol pressure, aided by favorable macro tailwinds supporting a strong adult tobacco consumer. Bottom line, we see a negative risk/reward on MO ahead of Q2 but encourage l.t. investors to build positions on any weakness in the stock.

Altria (MO) and Philip Morris(PM) were lower at recent check, while Reynolds was up slightly.

More at Barron's Stocks to Watch blog, http://www.barrons.com/stocks-to-watch