Altria: Why You Should Be Bullish Now

| About: Altria Group, (MO)

Share price of Altria Group (NYSE:MO) has gained 7.2% year-to-date. At $34.04, the stock is trading near its 52-week high achieved in July 2012 and offers an attractive 5.2% dividend yield. I believe income investor should consider adding this "must-have" investment at the current level based on the following five compelling reasons:

1. Consensus estimates predict Altria's revenue, EBITDA, and EPS to grow at 2-year CAGRs of 1.0%, 1.9%, and 10.6%, respectively (see chart below). Those figures are notably below the averages of 3.9%, 5.5%, and 14.0%, respectively, for a group consisting of Altria's primary peers. Similarly, the company's long-term earnings growth rate is forecasted to be 8.1%, which is below the peer average at 8.9%. On the profit side, Altria demonstrates an in-line performance as most of the company's margin measures are fairly on par. The firm's ROE is significantly above the peer average, though its ROIC underperforms. On the debt side, Altria carries a relatively lower level of debt as reflected by its below-average leverage ratios. In terms of liquidity, Altria has an above-average free cash flow margin. Both the firm's current and quick ratios are quite close to the group averages, reflecting a healthy balance sheet condition.

Given Altria's generally in-line financials relative to the peers', the stock's fair value should reasonably trade on par with the peer-average valuation level. The current price multiple at 14.2x forward EPS (next 12 months) is fairly consistent with the peer average at 14.1x, suggesting the shares are fairly priced relative to the comparable companies (see chart above).

2. Altria's forward P/E multiple is currently trading at a 2.8% discount to the same multiple of S&P 500 Index, which stands at 14.7x at the moment (see chart below).

I believe this presents an excellent entry opportunity as the stock's fair value should command a premium over the market level provided that 1) Altria shares traded over the market most of the time in the past 12 months and the market premium averaged at 7.7% in the period; 2) Altria's long-term earnings growth rate at 8.1% is comparable to the average estimate of 8.2% for the S&P 500 companies; 3) the company enjoys market-leading capital return and free cash flow performance; and 4) the stock offers a tempting 5.2% dividend yield which is considerably above the average of 2.2% yield for the S&P 500 Index.

3. Altria's financial fundamentals have demonstrated a solid performance over the past five years.

1) The company has been able to improve its capital return performance, especially return on equity, through additional leverage (see chart below).

2) Altria has also been able to produce higher profits as reflected by the rising profitability margins (see chart below).

3) Despite a downturn experienced in 2011, Altria saw a significant growth recovery across its revenue, EBITDA, and EPS in 2012 (see chart below).

Further, Altria's consensus revenue and EPS estimates have trended up slightly over the past six months, and analysts' average long-term EPS growth rate has been raised from 7.4% to 8.1% since 12 months ago, indicating an upbeat market sentiment on the stock (see charts below).

4. Altria's dividend growth prospects and its significant dividend yield offer a strong downside support to the share price. Since 2010, the company has raised the dividend per shares three times by 8.6%, 7.9%, and 7.3%, consecutively. Given the firm's robust free cash flow margin, I believe the current pace of the dividend growth should be sustainable. Moreover, Altria's dividend yield has experienced a strong correlation (0.72) with the yield for 10-year US Treasury Bond since 2010 (see chart below). As the Fed is likely to continue its easing policy, interest rate is expected to remain low in the near future, and this would help limiting the upside for Altria's dividend yield. As such, to test the stock's margin of safety, assuming a target dividend yield range from 5.0% to 6.0%, and supposing that Altria would raise the annualized dividend per share by 6.0% from the current level at $1.76 to $1.87 in September 2013 payment period, this somewhat conservative scenario would yield a share value range from $31.17 to $37.40, or a fairly balanced return range from -8.4% to 9.9% even without considering the 5.1% dividend income.

5. In a research note released in late February, Bonnie Herzog at Wells Fargo Securities commented on the company's growth prospects which I tend to agree on (sourced from Thomson One, Equity Research):

"MO Entering A Period of More Reliable and Sustainable Earnings and Free Cash Flow Growth - We have increased conviction that MO has multiple levers to drive accelerated earnings growth over the next few years. Levers include: (1) Lower net interest expense; (2) $400M cost savings program; (3) Aggressive share buyback program; (4) Valuable SABMiller stake; (5) $450M pre-tax benefit from MSA NPM Adjustment (assuming approved); and (6) The Federal Tobacco Buyout fee ending in 2015. MO re-affirmed its adj. dil. EPS guidance of $2.35 to $2.41 (+6-9%), which we think is conservative vs. our FY13 above-consensus est. of $2.44. MO remains our top U.S. tobacco stock pick and we encourage investors to aggressively build positions. We maintain our Outperform rating and $38 valuation midpoint."

In conclusion, in the light of the solid company financials, healthy growth prospects, reasonable valuations, and limited price downside helped by the lofty dividend yield, Altria should deserve a buy rating at this level.

All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the article and the charts are sourced from S&P Capital IQ unless otherwise specified.

Disclosure: I am long MO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.