In The Pursuit Of Dividends: Altria

Jan.24.14 | About: Altria Group, (MO)

In the pursuit of dividends, I try to think relatively and not in absolute terms. You will note many writers referring to dividends levels, such as 2%, 3%, 5%, and give such numbers some divine aura. This is not how I think. I prefer to think in relative yield terms, in the sense of how a particular dividends yield relates to the 30-year treasury, the 10-year treasury, and the 5-year treasury yields.

You see, if a company is paying more than the 30-year treasury, yielding 3.76% at the time of writing, then you should in reality treat it as a bond. In this case, capital appreciation should be of little, if any, primary concern. Capital preservation and dividend payout stability should be my paramount focus. In essence, this is what a bond is: a series of fixed payments for which you get the principal at the end.

For companies that pay above the 10-year bond rate, around 2.9% at time of writing, then dividends appreciation, in addition to capital preservation should be my prime concerns. In essence, I am accepting a slightly less yield, and I need to get something for it. In this case, a history of dividends growth is what I would be looking for. In reality, dividends growth would imply capital appreciation.

Capital appreciation starts playing into the game the closer you get to the 10-year yield. As such, for companies with dividends yield above the 5-year treasury, currently around 1.7%, one will need to start factoring in one's views of capital appreciation. My attitude would be that this is a decent enough yield, and I am willing to hold the company in case of an unforeseen price drop. Yet, the yield is not sufficient to sleep on for a prolonged time. As such, in the absence of measurable capital appreciation, such company would not be a good long term investment.

Considering companies that yield below the 5-year treasury falls under what I discussed in the prior article, and that is, a metric on management performance, and a gauge of how much trouble the company is running into. That is, for such low dividends, I will be after what the dividends represent and not the actual payout! In essence, here one needs to analyze for growth and capital appreciation, taking into account that dividends is just another barometer of the -- continuing -- health of the company.

Annaly (NYSE:NLY) -- for which I have written the first article in this series -- is the highest yielding company in my trading set. Altria (NYSE:MO), and AT&T (NYSE:T) come next.

Altria, which is a company that currently yields above the 30-year bond rate, is our focus here. At the time of writing, Altria has around $75 billion in market cap. It currently pays a quarterly dividend of $0.48, representing an annualized payout yield of around 5.12%. The company has been around for more than a century. Given my view of dividends in the introduction, an investment in MO falls under the "buy for the dividends" category. That is, capital and dividend preservation are what needs to be monitored to assure that the company is investment grade for this purpose.

Unlike the earlier article on Annaly, which benefited from my previous writings on that company, this is the first time I address MO in an article, beyond the synopsis I presented around New Year. Hence, bear with me, as this and subsequent articles will be more involved.

As an aside, old Philip Morris -- "Mighty MO" as brokers used to refer to it -- was in reality a holding company of many diverse businesses. The new MO, which shed many of its businesses over the last decade, has transformed itself into a "specialized private equity" fund, not unlike my view of Annaly as a "sophisticated fixed income hedge fund." Further, with MO's stated target of dispensing 80% percent of its "adjusted, diluted, earnings per share," you can truly think of MO in terms not far from a REIT that is mandated by law to distribute 90% of its taxable income.

To further address the dividends preservation issue, I would forward you to the dividends history list, where you can clearly see that the company has a consistent history of paying and raising dividends. Now, the drop you see in that 14 year history around June 2008 is related to divestiture of Philip Morris International in March of 2008.

Hence, from a dividends continuity perspective, MO exceeds expectations, due to its payout history and commitment to a payout ratio.

To address the capital preservation aspects, we need to look into the company as a whole. Altria owns USA based tobacco assets, where some of these assets were retained from its divestiture of Philip Morris International, while others are due to its acquisition of US Tobacco (the old UST), among others. It also owns different wine brands, and about a 27% stake in SABMiller. Altria maintains a financial services arm -- Philip Morris Capital. Yet, Altria thinks of itself as three segments: smokeable products, smokeless, and wine. Everything else is viewed as "other!"

To start, management is where one should initially focus. The management of MO and its directors do present themselves are quite competent. After all, Alrtia's Board of Directors reads like a Who's Who list with bios to match. Altria (the old Phillip Morris), is a century old company and clearly that heritage and culture seems to carry on. The executives are decently compensated, but not overly so, considering the size of the company.

Further, the company has managed to navigate itself from the abyss of the middle-1990's to its current status, while assuring that investors have reaped a phenomenal return, either in MO or its many spun-off subsidiaries, such as Mondelez (NASDAQ:MDLZ) -- the old Kraft.

The following analysis shall rely mainly on the latest SEC-filed quarterly report. As far as financials, examining this quarterly report, there are two points of concern that I see. The first -- see page 3 -- is that a significant amount of equity ($17 billion out of $36 billion) is in the form of Goodwill and Intangible Equity. In Altria's case, we know that their tobacco brands are some of the most valuable brands on Earth, regardless of category. Yet, given the USA focus, and the general anti-tobacco sentiment, it is clear that these assets are at continual -- though not imminent -- risk. The second point -- see page 19 -- relates to the fact that the bulk of their earnings are due to "smokeable" products.

In essence, as you would have guessed, the new MO is much more into smokeable tobacco than the old MO was. This is, from investment as well as ethical points of view, an issue that an investor will need to reconcile.

Otherwise, MO presents itself through its earnings reports as a very tight ship, worthy of investment.

Given the rising interest rate environment, one should also consider the debt liabilities of MO, as well as the Net Present Value of future cash flows -- dividends.

Given the growth rate of dividends, I am less concerned about the NPV of dividends. As it is clear that MO has compensated for that, throughout its history, by raising dividends payout. Yet, MO is a highly leveraged company -- page 4 in above quarterly report. In effect, shareholder equity amounts to only around $4 billion. As such, you should view MO as a cash flow machine, and not an equity box. Hence, you should keep a close eye on the cash flow analysis parts of future earnings statements. In essence, this emphasizes the view that MO is a perpetual annuity, or a bond, of sorts!

This takes us squarely into technical analysis to find a good entry point. Before we start, please note that many data services -- free and paid -- do not seem to provide the correctly adjusted values for MO's historic data. You see, the frequent divestitures -- (NYSE:PM), Kraft , SABMiller -- can cause some data vendors to misinterpret historic data. As such, be careful when doing your long term technical analysis of this stock.

The 10-year monthly chart below reveals a stock that has almost tripled over the last 10-years. More importantly, for a long term investor, is that the rate-of-appreciation of the price, other than the period around the financial crisis, seems to be very consistent. Actually, that rate is consistent over periods prior and post the financial. This type of consistency is rare for public issues on the market.

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Out of fairness to the real return of the company, one needs to look at the returns of SABMiller, PM, and MDLZ. This following chart summarizes that relative to MO.

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Looking for an immediate entry point, we resort to the 3-year weekly chart. Here, it is clear that the rate of price appreciation has slowed during the last 1 1/2 years. This can be somewhat attributed to the "return of risk" or the unusual 30% rise in the overall market last year, as well as the rising interest rates, which will impact the NPV of any future cash flows. That is, money moved from the likes of MO to more capital-appreciation type equities.

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In essence, this suggests an "averaging up" model, where one would accumulate on the way up, rather than doing bulk purchases when approaching investment in MO. This seems to me to be a better strategy in this current environment of rising interest rates. Especially that any correction in the market may affect MO.

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.