Investopedia Advisor submits: On August 17, a U.S. district court judge found the tobacco industry guilty of racketeering. Specifically the judge found that the industry, or rather several of its top players, including Altria (MO), Reynolds American (RAI), and Loews Corp (LTR), had essentially conspired and lied about the hazards, and addictiveness of cigarettes.
Now you think this would be bad news for cigarette companies, and that the finding would relegate the group to the doghouse. But, if this were your analysis, you would be wrong. Dead wrong! That’s because the judge did not impose any monetary fines based upon her ruling. In fact, she merely stated that the companies named in the suit would have to make corrective statements about the addictiveness of cigarettes, and pay the government’s court costs.
So where is the stock headed from here? In a word, higher! Here is what I like about the company:
Potential Kraft Spin-Off: This ruling is good for Altria, for the obvious reason that it won’t have to pay a big settlement.
But it is also good because it means the company may finally get its chance to spin off the remainder of its Kraft Foods (KFT) segment, which some estimate to be worth $47 billion. (Note to readers: According to Altria’s 10-K, the company currently retains ownership of about 87.2% of the company.)
You see, Altria had to wait until the smoke (no pun intended) from the government investigation cleared somewhat before spinning off the division because there was a distinct possibility that the combined company could have been hit with a big settlement figure. Put another way, it didn’t want to sell off one of its big money makers before the outcome of the case appeared clear. But again, with this ruling out of the way, it appears as though a spin off could happen, and that the company and its shareholders may reap the benefits should the spin off of Kraft come to fruition.
Dividend: Altria pays a quarterly dividend that contains a yield of about 4%. In addition, there is speculation that the company may raise its dividend payout based upon the news. If history is any indicator, management has upped the dividend more than 10 times over the past 12 years. Such a move, in my mind, could drive the stock even higher. But again, even without a dividend raise, 4% isn’t too shabby in this market!
Guidance Going Up: In late July the company reported second quarter earnings (excluding one-time charges) of about $1.40 a share. That was about 2 cents ahead of what Wall Street analysts were expecting.
The results can be credited to strong international shipment volumes, as well as the company picking up market share in a number of European and South American countries. Its Kraft segment also reported single digit improvements thanks to an improved product mix, and increased prices.
But perhaps most importantly, as a result of the company’s ability to deliver in the first half of the year, management raised its full year earnings outlook from $5.40 to $5.50 a share, from the $5.25 to $5.35 range that it had issued earlier in the year. This improved guidance is, in my mind, a good sign, and is likely to draw additional analyst research going forward.
China Connection: It is estimated that there are 200 million or more smokers in China, the world’s most populous country. For years, this potential market has been off limits as the China National Tobacco Corporation maintained a virtual monopoly over the country’s smokes. This has recently changed.
“Mighty Mo”, as the company is affectionately known on the street, inked a deal late last year to distribute its cigarettes in that nation. Now, what this means in terms of dollars and cents is just too hard to quantify at this time. Suffice to say that if the business does take off, I expect that management may be forced to ratchet its earnings projections even higher in the future.
Recession Stock: This one is simple folks. When the economy begins to slow, historical analysis reveals that people of all nations drink and smoke just as much if not more than during a healthy economy. Enough said.
Risks: Altria isn’t 100% out of the woods yet. In fact, down the line additional lawsuits and investigations could arise stemming from false advertising. You see, over the years, lots of people bought “low tar”, or “light” cigarettes. And lawyers are now making the claim that these products have been falsely advertised as being somehow better for you than the typical cigarette.
No matter what side you take on this issue, this won’t be a good thing for cigarette makers because it means that they will be a lot more cautious of how they advertise their products going forward. This in turn could lead to lower sales as more and more people realize the dangers of smoking.
Bottom line: I like Altria. It is a survivor that now appears to have the majority of the legal monkey off its back. They pay a terrific dividend. And the risks, at least in the near term, appear to be somewhat limited by comparison to past legal problems. I think the shares are worth $94 to $97 over the next year.
MO 1-year chart:
By Glenn Curtis, Contributor - Investopedia Advisor
At the time of release Glenn Curtis did not own any shares in any of the companies mentioned in this article.