Of all the billion dollar industries in the United States, few are dominated by so few large players than big tobacco. Last year’s merger between then second and third place companies Reynolds American Inc. (NYSE: RAI) and Lorillard only served to consolidate what was essentially an oligopoly, from a domestic perspective, into a duopoly.

Before the acquisition, Reynolds was forced to sell off some of its flagging assets to U.K.-based Imperial Brands, which at the time was called Imperial Tobacco, in an attempt to ensure this duopoly never arose. Recent activity suggests this attempt has failed, however. The ITG Brands division just announced job and production cuts at one of its major plants, and retailers are suggesting that ITG will become a “non player” by the end of 2016.

This leaves Reynolds and Altria Group Inc. (NYSE: MO) sitting pretty at the top of the U.S. market. But from an investment perspective, which looks like the sounder company? Alternatively, is there another play in the space worth looking at?

First, a couple of numbers. Over the past 12 months, Reynolds has far outperformed Altria, recording more than 33% gains versus Altria’s 10%. Further, this outperformance hasn’t led to a more expensive valuation. Reynolds holds a trailing price-to-earnings (P/E) ratio of 19.63, while Altria has a 22.99 comparable figure.

Looking internationally, Philip Morris International Inc. (NYSE: PM), the international spin-off of Altria that sells its products abroad, gained in line with its parent company over the past 12 months, ringing up a 10% increase in market cap. It currently holds a higher market cap than Altria —$142 billion versus $120 billion. It’s cheaper, too, with a P/E of 20.69. Dividends, a long-held attraction to the space, come in at 4.4%, 3.7% and 3.4% for Philip Morris, Altria and Reynolds, respectively.

From a purely quantitative perspective, it looks as though Reynolds makes for a more attractive domestic market allocation, but Philip Morris wins out for an investor looking to pick up exposure to international demand.

Do the fundamentals support this? Against a wider domestic backdrop of declining tobacco sales, chances are the longer term winner in U.S. markets will be the one that diversifies most effectively.

Electronic cigarettes have been on the radar of tobacco companies for half a decade now, but Altria has been far slower in picking up market share. Reynolds owns the two best-selling electronic cigarette brands in the United States, Vuse and Blu. These two brands account for more than 50% of U.S. unit sales, with the former out in front, compared to MarkTen (Altria’s offering), which accounts for less than 10%.

Having said this, Altria is set to gain from Anheuser-Busch InBev S.A./N.V.’s (NYSE: BUD) acquisition of SABMiller, that is if the deal ever completes. Additionally, job cuts are reported to be designed to free up capital for expanding safer tobacco products — the assumption being here that it is attempting to catch up to its rival in the electronic cigarette space.

Looking internationally, a number of the regions Philip Morris targets are growing, or at least slowing at a reduced rate, when compared to the U.S. domestic market. The company is aggressively targeting expansion in Russia, Latin America and certain parts of both Eastern and Western Europe, and this expansion could paint it as a more attractive growth proposition than its domestic counterparts.

So, what’s the final word? As mentioned, from a numbers perspective, Philip Morris looks attractive as an exposure to international markets, while Reynolds wins out domestically. Fundamentally, both Altria and Reynolds are diversifying to ensure expansion, but Reynolds just wins out based on its electronic cigarette dominance — though this could change before the year is out as Altria redirects spending toward its own offering in the space. In order of attraction, all things considered: Philip Morris, Reynolds, then Altria.

By Matt Winkler

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