Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how Reynolds American Inc. fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Reynolds American Inc. (RAI) is a holding company. The Company’s operating subsidiaries include cigarette manufacturer in the United States, R. J. Reynolds Tobacco Company; the smokeless tobacco products manufacturer in the United States, American Snuff Company, LLC (American Snuff Co); the manufacturer of cigarette brand, Santa Fe Natural Tobacco Company, Inc. (SFNTC), and Niconovum AB. RAI operates in three segments: RJR Tobacco, American Snuff and Santa Fe. The RJR Tobacco segment consists of the primary operations of R. J. Reynolds Tobacco Company. The American Snuff segment consists of the primary operations of American Snuff Co. Santa Fe manufactures and markets cigarettes and other tobacco products under the NATURAL AMERICAN SPIRIT brand.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 5/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
- Moderate PEmg ratio – PEmg is less than 20 – PASS
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$36.78|
|Value Based on 0% Growth||$21.56|
|Market Implied Growth Rate||5.55%|
Balance Sheet – 12/31/2013
Earnings Per Share
Earnings Per Share – ModernGraham
Reynolds American is not suitable for either the Defensive Investor or the Enterprising Investor. For the Defensive Investor, the turn-offs are the low current ratio and the high PB ratio. For the Enterprising Investor, the problem is the high level of debt relative to the company’s current assets. As a result, value investors seeking to follow the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities, such as through a review of 5 Undervalued Companies for the Enterprising Investor and 5 Low PEmg Companies for the Defensive Investor. From strictly a valuation standpoint, the company appears to be slightly overvalued. The company has grown its EPSmg (normalized earnings) from $1.97 in 2009 to $2.54 for 2013, but this level of demonstrated historical growth trails the market’s implied estimate of earnings growth of 5.55%. The ModernGraham accordingly returns an estimate of intrinsic value that is lower than the market price, so the company would seem to be overvalued.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on Reynolds American Inc. (RAI)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
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Disclaimer: The author did not hold a position in Reynolds American Inc. (RAI) or any of the other companies listed in this article at the time of publication and had no intention of changing that position within the next 72 hours.
Logo taken from the Wikipedia; this article is not affiliated with the company in any manner.