Just before January is set to end, Altria (MO) released its results for the final quarter of 2013. Continued price hikes of cigarettes and lower demand put pressure on the core business.
While cost control and the SABMiller stake, combined with the attractive dividend yield remain attractive, the core business remains under too much pressure to make the stock appealing in my opinion.
Fourth Quarter Highlights
Altria reported fourth quarter revenues of $6.08 billion, which is down 2.6% compared to the final quarter of 2012. Excluding excise taxes, revenues of $4.4 billion missed consensus estimates at $4.47 billion.
Despite the modest revenue declines, operating income was up by 2.0% to $1.86 billion. GAAP earnings more than halved to $488 million however. This was due to a $1.08 billion charge on the early extinguishment of debt, as earnings per share came in at $0.24 per share.
Earnings, which are adjusted for the debt extinguishment costs, came in at $0.55 per share, falling short to consensus estimates at $0.58 per share.
Cost Control Saves The Day
Altria did a good job keeping costs in check. Actual cost of goods sold fell by 44 basis points to 32.8% of revenues, while excise taxes fell by a full percent point to 27.6% of total revenues. This boosted operating profits, while the company managed to cut absolute selling, general and administrative expenses as well.
Note that over 90% of total revenues are being generated by cigarette sales. The company has a small wine business while the smokeless products business reported a 0.5% drop in revenues to $445 million.
A Quick Peak Back At Last Year
For the full year of 2013, Altria reported a modest 0.6% decline in revenues to $24.5 billion. Net earnings rose by 8.4% to roughly $4.5 billion and earnings per share growth approached 10% to $2.26 per share.
Altria has access to plenty of cash and equivalents, which stands at $3.2 billion. Yet total debt of $14.5 billion results in a sizable net debt position of little over $11 billion. Note that Altria's 26.8% interest in SABMiller (OTCPK:SBMRY) is worth $20 billion on the stock market, and not $6.5 billion as valued on Altria's balance sheet.
A Look At The SAB Stake
At $35.50 per share, the market values Altria at $71 billion. Altria has been pushed before to divest its stake in SABMiller. The company cited tax reasons and the diversification benefit which leads to lower borrowing costs as rationales to hold on to the stake.
Now if the company could divest its stake, which is valued at $20 billion, operating earnings would be reduced by a billion. In fact Altria pays more interest on its roughly $14.5 billion debt position than earnings it receives from its $20 billion stake in the company over the past year.
Such a move could cost the company $1 billion in pre-tax earnings, or let's say $700 million after tax. As such, annual earnings could fall from $4.5 to $3.8 billion based on last year's results, but the company would have access to $20 billion in cash. This could be used as a special dividend, or to retire debt for instance.
Note that if Altria would continue to operate with a similar capital structure, it could pay out a special dividend of roughly $10 per share, while operating earnings would only be impacted to the tune of 15%.
Not Interesting Enough
Altria remains a tricky case as revenues from the core business continue to be under pressure on the back of increased health consciousness, price hikes and increased excise taxes. As such, the core business continues to be in decline, but generates very meaningful cash flows in the meantime.
Altria has committed to paying out the majority of these cash flows to investors at a pace of $0.48 per share on a quarterly basis, providing investors with a 5.4% dividend yield. The search for yield kept stocks at high levels in this low interest rate environment.
As such, the stock acts as a bond, paying fat dividends at the moment, which surpass current interest rates, while the operations to support those future cash flows will undoubtedly continue to decline. For this reason, the price-earnings valuation at 16 times 2013's earnings is a bit steep, as the company applies very high payout ratios, which are approaching 100%.
Note that if the company were to divest the SABMiller stake and pay out proceeds as a special dividend, this ratio would be reduced to 14 times earnings. Given that the stake represents nearly 30% of the current valuation, it is being held as diversification to reduce volatility to the smoking industry.
I remain on the sidelines. Despite the very attractive yield and potential for value-enhancing moves through divesting some of the stake in SABMiller in the short term, the long-term business remains under pressure at a premium valuation.