Altria (NYSE: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).
- 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.
- 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.
- 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.
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.
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.