Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Altria (MO) in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess Altria's financial condition. The information that I am using for this article comes from the company's website here.
Note that this article is not a comprehensive review as to whether Altria should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
Altria is the biggest player in the U.S. cigarette business. Their operations are more diversified than those of their peers, with additional exposure to beer and wine, as well as a commanding position in the smokeless tobacco market.
Altria's business is divided into four segments. They are Smokeable Products, Smokeless Products, Wine, and Financial Services. The Smokeable Products segment accounted for almost 84% of the company's operating income in 2012. This segment includes cigarettes, machine-made cigars, and pipe tobacco. The Marlboro brand has been the company's best-selling cigarette brand for the last 35 years. In fact, Marlboro is the best-selling cigarette brand in the U.S., with a 43.7% market share. Of Altria's 135 billion cigarettes sold during 2012, 116 billion of them were Marlboros. The company also produces cigarettes under the Virginia Slims, Parliament, Benson & Hedges, Basic, and L & M brands. Their main brand of machine-made cigars is Black & Mild, obtained through the company's 2007 acquisition of John Middleton Co.
The Smokeless Products segment accounted for 12.5% of Altria's operating income in 2012. This segment produces and markets chewing tobacco under the Copenhagen, Skoal, Red Seal, and Husky brands. They also manufacture and sell the spit-free Marlboro Snus. This business came about due to the company's acquisition of U.S. Smokeless Tobacco Co. (UST) in 2009.
Altria's Wine segment accounted for 1.4% of operating income and includes the operations of Ste. Michelle Wine Estates and its premium wine business.
The Financial Services segment contributed 2.4% of the company's operating income in the form of Philip Morris Capital Corporation (PM). This segment manages the company's portfolio of finance assets. They hold investments in finance leases in many industries, including aircraft, rail and service transport, electric power, real estate, and manufacturing.
Altria is also involved in the beer business, with a 26.8% economic and voting interest in SABMiller (OTCPK:SBMRF).
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets as they might be more inclined to buy back stock with it, or pay out dividends.
Altria is one such company. As of Sept. 30, 2013, Altria had $4.21B in cash and cash equivalents, which can be easily converted into cash.
Over the last 12 months, Altria paid out $3.54B in dividends and bought back $891M worth of stock. These activities were covered by the company's free cash flow of $4.62B.
Altria has increased its dividend 46 times in the last 44 years. They most recently increased their dividend by 9.1% this past August. Management has stated that their target dividend payout ratio is 80% of the company's adjusted earnings per share.
The company also recently expanded its existing share repurchase program by $700M to $1B. As of Sept. 30, 2013, the company had $709M remaining on that authorization, which they expect to complete by the end of the third quarter in 2014.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of Altria is 0.91, which is less than ideal. This figure implies that if all operations at the company came to a grinding halt, then the company may have trouble in trying to meet its short-term financial obligations without having to resort to debt. However, when considering this figure, you need to think about the likelihood of something like that happening. Barring a major catastrophe in Richmond, Va. where the company is headquartered, I think that the possibility of their entire operations being shut down is very remote.
Property, Plant and Equipment
Every company, regardless of the industry in which it operates, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.
However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors. Right now, Altria has $2.04B worth of property, plant and equipment on its balance sheet. This figure is inline with the $2.10B that the company reported at the end of fiscal 2012, as well as the $2.22B that it reported at the end of fiscal 2011. Of these assets, 65% is tied up in machinery and equipment and 27% is in buildings.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case-by-case basis as good companies are rarely purchased at or below book value.
Altria has $5.17B worth of goodwill on its most recent balance sheet, which matches what it had in goodwill at the ends of each of the last three fiscal years. $5.02B of this goodwill is from the company's 2009 acquisition of UST.
Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed at the beginning of this section. Since goodwill only accounts for a little over 14% of Altria's total assets, I don't see much to worry about here.
Intangible assets that are listed on the balance sheet include items such as licensed technology, patents, brand names, copyrights and trademarks that have been purchased from someone else. They are listed on the balance sheet at their fair market values. Internally developed intangible assets do not go on the balance sheet in order to keep companies from artificially inflating their net worth by slapping any old fantasy valuation onto their assets. Many intangible assets like patents have finite lives, over which their values are amortized. This amortization goes as annual subtractions from assets on the balance sheet and as charges to the income statement. If the company that you are researching has intangible assets, with finite lives, that represent a very large part of its total asset base, then you need to be aware that with time, those assets are going to go away, resulting in a reduction in net worth, which may result in a reduction in share price, unless those intangible assets are replaced with other assets.
Altria currently has $12.1B in intangible assets. This figure also matches what the company reported at the ends of each of the last three fiscal years. These assets stem from the company's acquisitions of UST and John Middleton. Of that total, $9.1B are from trademarks that the company acquired in the UST deal, and $2.6B are from acquired trademarks in the John Middleton deal.
Of the $12.1B in acquired intangible assets, $11.7B are classified as indefinite-lived assets, which do not come off of the balance sheet due to amortization. So, at this point in time, there is no concern about the impact that losing intangible assets might have on Altria's stock price.
As mentioned before, Altria has a 26.8% economic and voting stake in SABMiller. This stake is valued on the balance sheet at $6.52B, using the equity method of accounting. However, if this stake is valued using mark to market, then based on SABMiller's stock price, the stake would be worth about $21B.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For Altria, the return on assets would be $4.74B in core earnings over the last 12 months, divided by $36.0B in total assets. This gives a return on assets for the trailing twelve months of 13.2%, which is very good. I also calculated Altria's returns on assets over fiscal years 2012, 2011 and 2010 for comparative purposes. This can be seen in the table below.
Table 1: Strong And Growing Returns On Assets At Altria
In Table 1, we see that Altria's returns on assets are strong, and that they have been growing, as the company's earnings have been growing while the asset base has essentially stayed the same. This shows that thus far, management has done a fine job with the assets at its disposal.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
Altria currently has $1.98B worth of short-term debt, all of which is the current portion of its long-term debt. Given the company's free cash flow generation of $3B - $4B in each of the last three fiscal years, its existing cash position of over $4B, and the ability to refinance some of this debt at very low interest rates, this short-term debt should not be a problem for Altria.
Long-term debt is debt that is due more than a year from now. An excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
On Sept. 30, 2013, Altria carried $12.9B of long-term debt. This figure is slightly above the $12.4B that was reported just 9 months prior, but slightly below the $13.1B that was reported at the end of fiscal 2011. Of this debt, 29% is due within the next five years. Maturities on the company's long-term debt range from 2014 to 2042.
However, it should be mentioned that since the latest balance sheet came out, there have been some developments in this department. The company recently completed a debt tender offer in which they repurchased $2.1B worth of long-term debt, with interest rates ranging between 9.25% and 10.2%, which is terrible to have to pay in this low-rate environment. In order to complete this transaction, the company sold $1.4B in debt at 4% with a maturity of 2023, and $1.8B in debt at 5.375% with a maturity of 2043. While this represents a net increase in their long-term debt, it will reduce the interest that they'll have to pay in the years to come. The company also did a similar deal in 2012.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of Altria over this period is $4.23B. When you divide the long-term debt by the average earnings of the company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For Altria, here is how it looks: $12.9B / $4.23B = 3.05 years
This is good for Altria in that the company can pay off its long-term debt with an amount that equates to roughly three years' worth of profits. If rates stay low, they can even refinance some of the debt. To me, this shows that the company's debt position is very manageable when considering the company's earnings power and free cash flow generation.
In the equity portion of the balance sheet, you will find the treasury stock. This figure represents the shares that the company in question has repurchased over the years, but has yet to cancel, giving the company the opportunity to re-issue them later on if the need arises. Even though treasury stock appears as a negative on the balance sheet, you generally want to see a lot of treasury stock, as strong, fundamentally-sound companies will often use their huge cash flows to buy back their stock. For this reason, I will often exclude treasury stock from my calculations of return on equity and the debt-to-equity ratio in the case of historically-strong companies. The negative effect that the treasury stock has on the equity may make the company in question appear to be mediocre, or even severely distressed, when doing the debt-to-equity calculation, when in reality, it might be a very strong company. In this case, I will try to calculate the debt-to-equity ratio and the return on equity both ways to help give the reader an idea as to how much effect the treasury stock really has.
Altria, which most can agree is a historically-strong company, has a whopping $26.1B in treasury stock.
The debt-to-equity ratio, as normally calculated, is simply the total liabilities divided by the amount of shareholders' equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how Altria stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholders' Equity
For Altria, the debt-to-equity ratio is calculated by dividing its total liabilities of $31.9B by its shareholders' equity of $3.98B. This yields a debt-to-equity ratio of 8.02.
By looking at this figure alone, you would be led to believe that Altria is in a state of severe financial distress, maybe even on the verge of bankruptcy.
However, keep in mind that Altria is not in a capital-intensive industry that requires a lot of large capital expenditures. In fact, less than 3% of Altria's operating cash flow went to capital expenditures, translating into lots of free cash flow that the company can use for other things. Altria doesn't need as much equity as say, an oil exploration and production company. As can be seen from the treasury stock figure, Altria has chosen to use its free cash flow to buy back stock, resulting in a reduced equity position.
In my opinion, when you cancel out the negative effects that the treasury stock has on the equity, it paints a more realistic picture of the company's debt burden.
In these instances, I calculate what I like to call the adjusted debt-to-equity ratio. It is calculated as follows.
Adjusted Debt-To-Equity Ratio = Total Liabilities / (Shareholders' Equity + Treasury Stock)
Using the data from the most recent balance sheet of Altria, this figure is calculated as: $31.9B / $30.1B = 1.06. The tables below show how both the normal and adjusted debt-to-equity ratios have changed over the last few years.
Table 2: Debt-To-Equity Ratios Of Altria
Table 3: Adjusted Debt-To-Equity Ratios Of Altria
A lot of folks will disagree with my adjusted debt-to-equity calculation, and that's fine, but here, we see what difference it makes when the treasury stock is stripped from the debt-to-equity calculation. The debt-to-equity ratio drops from high levels of between 6 and 10 to right around 1.
For this reason, as well as the company's free cash flow generating ability, I don't see a need to panic here.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholders' Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies (like Altria) are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be.
So, the return on equity for Altria is as follows:
$4.74B / $3.98B = 119%
This is a ridiculously high return on equity. Table 4 shows how this figure has changed over the last few years.
Table 4: Returns On Equity At Altria
Table 4 shows that the returns on equity have been sky high over the last several years. However, this has more to do with the company's reduced equity position than it does with their earnings.
Adjusted Return On Equity = Net Income / (Shareholders' Equity + Treasury Stock)
When I strip out the negative effects of the treasury stock, here is what I come up with when using the data from the most recent balance sheet.
Adjusted Return On Equity = $4.74B / $30.1B = 15.7%.
This appears to be a pretty solid return on equity. In the table below, you can see how the adjusted return on equity has fared over the past three years.
Table 5: Adjusted Returns On Equity At Altria
Table 5 shows that the adjusted returns on equity have been consistently strong as the company's core earnings have risen at a faster rate than the company's adjusted equity position.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Altria currently has an impressive retained earnings figure of $25.6B. Below, you can see how the retained earnings have fared at Altria at the ends of each of the last four fiscal years.
Table 6: Retained Earnings At Altria
From the above table, you can see that the retained earnings at Altria have grown at a relatively slow rate since the end of fiscal 2009, at a cumulative rate of 13%. However, this has been happening as the company has been buying back stock and paying out nice dividends. Given that Altria does not operate in an industry that requires constant innovation and large amounts of capital expenditures, this slow rate of retained earnings growth is fine by me.
After reviewing the most recent balance sheet, it can be concluded that there are a lot of things to like about the financial condition of Altria. For one, Altria has nearly $12B in trademarks and other intangible assets that can't be lost to amortization, due to acquisitions that the company made in order to diversify away from just cigarettes. In addition to that, they are also diversified into the beer and wine business, as can be seen by the company's stake in SABMiller. Altria has solid returns on assets, showing that management is making good use with the assets at its disposal. The company's short and long-term debt positions are manageable when compared to the company's cash position and earnings power. Altria is also being proactive when it comes to retiring high-interest debt in exchange for lower rates.
While this is not a comprehensive review as to whether Altria should be bought or sold, I think that the company is in good financial shape at this point in time, with its manageable debt, economic moats, brand strength and tremendous earnings power.
For more information on how I analyze financial statements, check out my website at this link.
Thanks for reading and I look forward to your comments!