In Jeremy Siegel's book, The Future for Investors, Professor Siegel noted how Altria (NYSE:MO), the former Philip Morris (NYSE:PM), was the best performing stock from 1925 through 2003. Siegel theorized that this was because the stock price for the stock was held down by investors' fear of litigation and declining smoking rates, etc. Thus, investors in Altria were able to buy MO's steady earnings growth for bargain prices. Because MO was almost never overpriced, MO's steady earnings growth and generous dividend made for great long-term returns.
I believe that same scenario of steady earnings growth and generous dividends still exists today and investors will be well rewarded by investing in Altria.
Altria's four main businesses are: cigarettes, cigars, smokeless tobacco, and wine. Altria also benefits from a 26.8% interest in SABMiller and has begun a national roll-out of an e-cigarette. The majority of the profits are derived from the overall tobacco business, a category Altria dominates. Altria's tobacco businesses earned approximately 51% of the total U.S. tobacco profit pool in 2013, more than twice that of its largest competitor.
Is cigarette smoking declining? You bet it is. Cigarette use has been declining about 3% to 4% a year for the last 7 years. The exception being in 2009, when a large tax increase helped drop use by 8%. However, cigarettes are still a $66 billion business and Altria has by far the largest share of that market at 51%. In addition, Altria's Marlboro brand has a 43.7% share of the market, which is larger than the next 10 brands combined. Marlboro's share has grown from 42.9% in 2008 to the 43.7% it is today.
Despite the limited ability to do so, Altria is able to market its leading Marlboro brand through websites and point of purchase signage. Through this marketing, Altria has been able to expand its product offerings. For example, Marlboro is now offered in four varieties: Red, Gold, Green, and Black. Each offering is marketed to a different smoker segment. Marlboro Black has been growing share and building a strong position with smokers.
Altria manages product pricing to offset the low single digit decline in sales. Marlboro's brand loyalty allows Altria to steadily increase prices. The net price of a pack of Marlboro has increased from $4.27 in 2009 to the current $5.86. So while cigarette use declined by approximately 23% over the last five years, cigarette prices increased by approximately 37%. The Marlboro premium price is 35% higher than the lowest-priced brand.
Altria competes in the machine-made cigar category with the Middleton brand. Recent competition from cheaper foreign machine-made cigars has reduced Middleton's retail share from 31.7% in 2009 to the current 29.4% share. Altria has focused on growing income from the cigar business by controlling costs while maintaining margins.
The smokeable products category (cigarettes and cigars) has grown income at a compounded annual growth rate (CAGR) of 4.2%. In 2013, income from smokeable products was $6.4 billion, up from $5.2 billion in 2008.
In September 2008, Altria agreed to buy UST, the maker of Skoal and Copenhagen smokeless tobacco. Altria has managed the business well, growing volumes and increasing retail share. In 2009, Skoal and Copenhagen accounted for sales of 646 million packages. That sales total grew to 788 million packages in 2013, a CAGR of 5.1%. Copenhagen's and Skoal's combined retail share has grown from 47.3% in 2009 to 50.7% in 2013.
Copenhagen has been the best performer in the smokeless segment. In 2009, Copenhagen had a retail share of 22.5%, that has grown to the current 29.3%. Copenhagen's share of the natural segment is just under 75% and its share of the wintergreen segment has grown from almost nothing in 2009 to approximately 7% today.
Skoal's overall market share has fallen from 24.8% in 2009 to 21.4% today. Some of this decline can be attributed to lower price competition as Skoal's price is 55% higher than the leading discount brand.
Altria's smokeless tobacco products have grown income from $632 million in 2009 to just over $1 billion today, a 12.9% CAGR.
The onset of e-cigarettes is a relatively new phenomenon and Altria is a little late to the party. The small, but growing market is dominated by Lorillard's (NYSE:LO) Blu e-cigs. E-cigarettes was a $300 million business in 2011, but has quickly grown to an approximately $1 billion business in 2013.
Altria's e-cigarette division, Nu Mark, has launched its MarkTen product in Indiana and Arizona. During the recent CAGNY conference, Altria management had this to say about its market test in Arizona: "Although it's still early, Nu Mark's results in Arizona have exceeded our expectations. In just seven weeks, MarkTen has achieved brand leadership there, with a current market share of 48%."
Altria now intends to launch the MarkTen e-cigarette nationally.
Altria also recently bought Green Smoke Inc., an e-cigarette company that was founded in 2008. Green Smoke had $40 million in revenue in 2013 and derives most of its sales from the internet.
In addition, Altria recently signed an agreement with Philip Morris International, which provides Philip Morris with an exclusive license to sell Altria's electronic cigarette products internationally. In turn, Philip Morris will provide Altria with two of its next-generation products that heat tobacco instead of burning it.
As it has done with its other businesses, Altria plans to provide a superior product at a higher price point. Altria will also engage in brand building and developing customer relationships. It is still early, but I believe Altria is intent on dominating the e-cigarette business.
Ste. Michelle Wine Estates
When Altria acquired UST in 2008, Altria also got Ste. Michelle Wine Estates, best known for its Columbia Crest and Domaine Ste. Michelle wines. Chateau Ste. Michelle has been named "Winery of the Year" 19 times. Altria has grown income from Ste. Michelle by a CAGR of 12% since 2008.
In 2002, the then Philip Morris Company sold the Miller Brewing Company to South African Breweries. Today, Altria maintains a 26.8% equity interest in SABMiller (SAB.L). The equity interest in SABMiller has seen equity earnings grow by a CAGR of 16.2% since 2008. The value of Altria's interest in SABMiller has grown from $7.3 billion in 2008 to $19.4 billion in January 2014. Altria evaluates its stake in SABMiller every year; for now, it believes that maintaining that stake is in the best interest of shareholders.
For years I have read that Altria is a no-growth or slow growth company; that simply is not true. The smokeable products category is growing income by a CAGR of 4.2%. The smokeless tobacco unit is growing volume by a CAGR of 5.1% and income by a CAGR of 12.9%. The wine business is growing sales and growing income by a CAGR of 12%. Altria's equity in SABMiller has grown equity earnings by a CAGR of 16.2%. It is too early to tell how the e-cigarette business will turn out, but MO has set itself up well to benefit. Altria is an income machine and it continues to grow the income stream in the mid-to-high single digits.
For the record, Altria has a small capital business it is now winding down with the intention of completely exiting.
Altria's stated goal is to grow income for the shareholders and it does an outstanding job of creating that income. One of the ways Altria does that is by controlling costs. Altria has reduced its weighted average coupon rate on its debt by 3.2% since 2009. Currently, Altria's average coupon rate is 5.9%. Altria also has taken cost saving measures that generated $2 billion in productivity savings.
Altria pays out 80% of its earnings in dividends. Since the spin-off of PM, Altria has increased the dividend 8 times in 7 years and currently yields 5.4%. Altria has been increasing the dividend at CAGR of 8.8%.
Altria also repurchases shares. Altria has repurchased approximately $4.2 billion of shares since the PM spin-off. Through the end of 2013, Altria repurchased shares valued at more than $540 million under the current $1 billion program, which should be completed by the end of the third quarter of 2014.
It also grows income by steadily growing earnings. Since 2008, Altria has steadily grown earnings in the mid to high single digits. The chart below shows the steady increase in earnings.
Altria has forecast earnings growth of 6% to 9% for 2014.
Doing the Slow Grind
The beauty of Altria is that the stock never gets over-priced. The stock always seems to be priced with a P/E in the area of 15 to 16. Currently the stock has a P/E of 16. With a P/E of 16, it doesn't take long for earnings that are growing at a rate of approximately 7-8% to catch up to the P/E.
An investor in MO knows when the year starts that they are going to receive a dividend of over 5%. As the earnings grow, the stock price creeps higher. With a stock price of approximately $36, it only takes a $2 price move to generate a double digit return for an investor. That small price move, along with the generous dividend, is exactly how Altria generates its S&P 500 beating returns. Since 2008, Altria has returned 137%, while the S&P 500 has returned 44%.
With its generous dividend and small price movements, Altria slowly but surely moves higher, year after year, like a glacier.
Back in 2012, I wrote an article called My Investment Advice - Do Nothing. In that article, I detailed several investments I had made, which if I had held instead of selling, would have provided great returns. One of those investments was Altria. I purchased Altria in October 2006 for $78.78 and then sold the shares in January 2007 for $85.67. If I had held through the split and held all the spin-off companies, I would have more than doubled my investment. It is my intention to add Altria and this time, not sell.
I am currently about 80% done building a position in Ventas (NYSE:VTR), a healthcare REIT. I should have a full position in VTR within the next month, at which time I will begin building a position in MO. One of the nice things about Altria is you never have to chase the stock, because there is no chance it is going to rocket ahead. Altria grows slowly, but steadily, so there is always time to build the position. Buy and hold and let the slow grind higher begin.