When looking at the yields of the major tobacco companies, they may seem too good to be true. This is especially true for Altria Group (MO), the highest yielding of the big tobacco companies, and also the best-run company in the sector, in my opinion. Let's take a look at the company, where it may be heading, and if the dividend is sustainable going forward.
Formerly known as Phillip Morris, Altria is a holding company with some of the most popular tobacco brands in the world among its portfolio. The company produces such cigarette brands as Marlboro (bestselling brand in the U.S.), Merit, Basic, Virginia Slims, and Parliament, just to name a few. The company also has an extensive wine business, including the Chateau Ste. Michelle Wine Estates as well as such wine brands as Fourteen Hands, Stag's Leap, Seven Falls, and about a dozen more. Altria also owns U.S. Smokeless Tobacco Company, with the popular brands Skoal and Copenhagen.
Beware of the anti-smoking trend?
With the anti-smoking trend in the U.S., should investors be worried? I would say "not really", and for a couple of reasons. First, although the percentage of adults in the U.S. is definitely dropping, the actual number of smokers is staying relatively constant. For example (not factual numbers), let's say that in 1960 about 50% of the adults in the U.S. were smokers and the total adult population was 75 million, meaning that 37.5 million U.S. adults were smokers. Let's also say that in 2010 that only 20% of American adults smoked, but the population had risen to 180 million adults, meaning that 36 million adults were smokers (the actual number of U.S. smokers today is around 45 million). In other words, the effects of the rising U.S. population is somewhat offsetting the lower percentage of smokers.
Also, with the invention of electronic cigarettes, tobacco users have an additional option besides quitting smoking outright. Even regular smokers are using electronic cigarettes some of the time, like in bars and restaurants where cigarette smoke is not allowed. Altria launched its first e-cigarette this summer through its NuMark subsidiary, and although this is a young industry, research has suggested that Altria could add $5 billion in value to its company by capitalizing on the e-cigarette market while it's still in its infancy.
Altria pays a very generous dividend yield of 5.5% annually ($1.92 per share), which is the highest among the major tobacco companies and has been raised regularly throughout the years. My only concern is whether or not the yield is sustainable. The company is expected to report 2013 earnings of $2.39 per share, which would represent a relatively high 80.3% payout ratio. The consensus calls for earnings of $2.56 and $2.74 in 2014 and 2015, respectively, which represents earnings growth of 7% annually. Since the dividend is already stretched pretty far, I wouldn't expect increases of any more than 5-7% annually going forward.
While Altria and other big tobacco companies can provide you with a fantastic stream of income, know that their growth days are probably behind them. Over time the decline in smokers could definitely erode profit margins, but for now it's not too much of a concern. The tobacco giants are still excellent options for a steady income stream that should come with nice annual raises.