Buying Altria? Profit While Awaiting Improved Market Conditions

Altria (MO) is the largest U.S. cigarette producer. It spun off Kraft Foods (KFT) in 2007 and its international cigarette business in 2008. Altria acquired UST Inc. (a world’s leading moist smokeless tobacco manufacturer) early in January, 2009 for $11.7 billion, including $1.3 billion in debt. This acquisition was substantially financed with debt.

Altria is composed of three unrelated businesses as follows:

• The tobacco and tobacco-related businesses, the predominant sector. The strategy is to grow the business organically and through acquisitions.
• The financial services component which principally represents active investments in leveraged leases, carrying non-recourse debt. Net book value is $5.6 billion, compared against $20.7 billion total assets. The strategy in this segment is to manage the run-off of the leases with minimum disruption of the tax implications (due to unfavorable IRS rulings).
• The 28.6% investment in SAB Miller, a brewing company, a passive investment. Market value is approximately three times $4.15 billion, book. The strategy behind holding this investment is not clear. From this perspective, selling this investment (at a gain) to repay debt makes sense.

Free Cash Flow

Annual free cash flow of the tobacco business – essentially based on the pro-forma financials which incorporate the U.S. Tobacco acquisition – amounts to $4.28 billion. This translates to an operational enterprise value of $89.11 billion, assuming a perpetual free cash flow growth rate of 4% and 9% in weighted average cost of capital.

Altria’s equity value, after adjusting for the book value of SAB Miller and $12.57 billion of debt amounts to $80.69 billion, or a stock value of $38.42/share. This compares against a market price of under $16.00. (A reduction in the perpetual free cash flow growth rate to 1% results in a stock value of $21.75/share).

Some Caveats

1. The value of the financial services portfolios from two perspectives; (a) future IRS rulings which may negatively impact historical taxes and earnings recognition, (b) the intrinsic value of the leases, mostly leveraged leases. A cursory review of the notes to the financial statements suggests that the leases’ credit takers are sound and that the assets values (and recovery values) are adequate to avoid losses.
2. The investment risk in SAB Miller, particularly Altria’s ability to sell SAB Miller at favorable price (close to market values) to deploy the funds in areas of strategic emphasis, or repay debt to lower Altria’s risk profile.
3. The impact of negative tobacco legislation / negative outcomes from pending suits. This is a tough one to quantify. However, it would seem that Altria’s $80.69 billion, equity value, is a large cushion to cover for such unexpected costs, and that only a minor portion of it would suffice to cover such risks.

Dividend Coverage

Pro-forma EBITDA is $5.43 billion. This amount should be sufficient to cover annual dividends of $2.64 billion plus servicing of $12.57 billion in gross debt. Note that the pro-forma EBITDA amount does not include the benefits of the U.S. Tobacco acquisition synergy, or those planned by Altria before the acquisition.

Fundamental Value

All in all, it would seem that the spread between the estimated stock value ranges and $15.79 market price as of 1/12/09, provide some protection from the unexpected outcomes and still provide an attractive return. Further, an 8.1% p.a. dividend ($1.28/year) entices one to buy now and get a nice dividend while awaiting for better market conditions.

Disclosure: I hold a long position in Altria’s common stock.

Comments

[Larry House:]

I am not sure if you a saying wait to buy MO or buy it and hold it until market conditions improve. I think you have built a great case for buying it now, enjoy the generous and safe dividend, and sell it when market conditions improve. That is what I am doing, and I plan to add to my position this week. I think it is a great stock to hold in this unsettled time, but when market conditions improve, I think growth stocks will perform better. Right now, 8% dividend, relative safety, and some price appreciation potential looks fine to me.

Jan 13 10:39 AM

[User 336457:]

I do not know a lot about stocks, but I do know Altria, and its business practices after working in management for 31 years in Richmond for them. It is the most well run company and its business stratigy is second to none. We are in Forida for the winter enjoying the fruits of our long hard labor. Thank you Altria, and PM, and Kraft. I will keep buying Altria each and every month.

Jan 13 11:06 AM

[Gino Verza:]

Sorry for the confusion.

I am saying buy now and get a nice dividend while awaiting for better market conditions (I have submitted a clarification in the wording in the article). .

I hold a long position in Altria.

Jan 13 11:06 AM

[tellingson:]

In the face of billions of debt perhaps someone would explain their conviction that the dividend is safe? It appears that the dividend drives
the purchasing concept.
Thanx, sincerely

Jan 13 12:31 PM

[Gino Verza:]

Thank you for the question, Tellingson,.

Annual EBITDA for the pro forma financials, including UST and related debt, is estimated at $5.5 billion (before earnings contribution from SAB Miller). EBITDA is sufficient to cover the annual uses of funds estimated at $4.5 billion ---$2.6 billion in dividends, $1.3 billion in interest expenses, and $0.6 billion in debt principal repayments –and generate a $1.0 billion surplus. These uses of funds and others are discussed below.

Uses of Funds
(a) Dividends --$2.6 billion in dividends

(b) Interest Charges --$1.3 billion in interest payments for $13.0 billion in gross debt ($12.5 billion in tobacco debt and $0.5 billion in recourse lease portfolio debt) at an estimated overall average interest rate of 9.48% p.a. (see below).

Actual Debt Information:
Total debt amounting to $13.0 billion is made up by $7.0 billion medium/long term debt and $6.0 billion, short term. Breakdown is as follows:

Medium/Long Term Debt:
(i) $1.4 billion in 8.50% Notes due 2013
(ii) $3.1 billion in 9.70% Notes due 2018
(iii) $1.5 billion on 9.95% Notes due 2038
(iv) $1.0 billion in other medium/long term debt
Total Medium/Long Term Debt is $7.0 billion

Weighted average maturity is 12.8 years
Weighted average interest rate is 9.48%.
Average annual principal amortization is $0.6 billion,

(c) Principal Debt Amortization --$0.6 billion in the estimated annual amortization. This is based in the following:
(i) Medium/long term debt average maturity of 12.8 years
(ii) Short term debt (substantially supporting working capital assets) is rolled over.

(d) Net Operations Working Capital Use and Capital Expenditures –Historically the working capital requirement to support revenues is minimal, if not a source of funds. Following the recent UST acquisition prospective emphasis is on the integration of the acquisition into the existing tobacco business rather than on additional capital expenditures.

(e) Income Taxes –This is a tough one. The lease portfolio seems to be the predominant source of deferred taxes. The strategy to manage an orderly portfolio run-off will tend to reverse earlier deferrals, net of lease sale revenue (and lease residual gains). There is no evidence of problems with the underlying assets or the paying capacity of the lessees. From this perspective, some unfavorable choppy tax impact due to the run-off or to adverse tax rulings should not be surprising. See the caveats in the article.

Debt Servicing Factors
(a) The stability of tobacco EBITDA supports greater debt-carrying and debt-paying capacity than otherwise possible.
(b) The economic life of the assets acquired (UST) quite likely exceed the average maturity of medium/long term debt. In other words, the assets acquired will continue to generate cash flow well after acquisition debt is repaid.
(c) Lenders’ willingness to finance (extend or rollover) is principally based on the strength and stability of cash generation from the tobacco business. Quite likely, additional consideration is given to the financial flexibility related to the (potential cash flow from the) SAB Miller investment and the leveraged lease portfolio.
(d) Altria has proven adept in the operation of a tobacco business and in the management of cash flow (read debt management) under similar leveraged circumstances. (None of the synergistic improvements envisioned in the acquisition are built in the estimates).

Value Drivers
The article points to free cash flow generation as a driver in the value of the stock. Other drivers are the expected growth in free cash flow and the cost of capital.
Altria’s dividend paying-capacity derives from its capacity to generate cash flow ---to support operations (net operations working capital and taxes), expansion (capital expenditures), and to pay for financing sources (debt and dividends), as discussed above.

In the final balance, the view that the dividend is safe and price appreciation likely seems like a reasonable value proposition.

Please do your own due diligence.

Sincerely,

Gino Verza

Disclaimer: I hold a long position in Altria’s common stock.

Jan 13 08:47 PM

[Victhom:]

Just few words....Now Altria own 28.6% of #2 World Beer producer on this planet and with UST we got 100% of the best US best wine producer.....and this has very good growth prospect....in long term.....and SAB Miller is the world’s largest bottlers of Coca-Cola products...Do not forget this...LOL

www.altria.com/about_a...

www.sabmiller.com/inde...

Jan 14 05:54 AM

[Victhom:]

One of the world’s largest brewers, SABMiller has brewing interests and distribution agreements across six continents.

Our wide portfolio of brands includes premium international beers such as Pilsner Urquell, Peroni Nastro Azzurro, Miller Genuine Draft and Grolsch along with market-leading local brands such as Aguila, Miller Lite, Snow and Tyskie.

Six of our brands are among the top 50 in the world. We are also one of the world’s largest bottlers of Coca-Cola products.

Over the past 21 years we have grown rapidly from our original South African base into a global operation, developing a balanced and attractive portfolio of businesses.

Our markets range from developed economies such as North America to fast growing developing markets such as China and India.

Jan 14 05:55 AM

[Alex Lann:]

Altria has generated 19% compounded since 1957. This fact far and away transcends any analysis provided by commentators. It is a rare person who can understand how this company thinks and acts.

Jan 19 12:49 AM