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Summary

  • Altria owns 27% of international beer giant SAB Miller.
  • Altria management expects solid earnings per share growth going forward.
  • The company has a strong dividend yield of 4.50%.
  • Altria has partnered with Philip Morris for international e-vapor sales.
  • Altria’s acquisition of Green Smoke further strengthens the company’s e-vapor position.

Altria (NYSE:MO) manufactures and sells tobacco products in the US through its Marlboro, Copenhagen, Skoal, and Black & Mild tobacco brands, among others. The company also sells wine through the St. Michelle's Wineries division. Additionally, Altria sells e-vapor products through its Nu Mark division, which includes the MarkTen and Green Smoke brands. Finally, Altria owns a 27% stake in SAB Miller, the international beer business whose flagship brand is Miller.

A $1,000 dollar investment in Altria (then called Philip Morris) in 1957 would have been worth $5.8 million by 2007, making Altria the single stock with the highest return over that time period. Altria has spun-off several of its old business units since 2007 to focus on its core tobacco business. In 2007, Altria spun off Kraft (NASDAQ:KRFT). The next year Altria spun-off its international tobacco business, calling it Philip Morris International (NYSE:PM).

Current Events

The bulk of Altria's profits come from the cigarette industry. The US cigarette industry has been in slow decline for years. More and more people choose not to start smoking due to the overwhelming amount of information that warns people of the negative health consequences of smoking. The US government has also imposed a heavy tax burden on the tobacco industry, increasing the cost of cigarettes.

(click to enlarge)
Source: Altria Group CAGNY Conference

Altria operates in 3 segments: Smokeable Products, Smokeless Products, & Wine. Altria's Smokeable Products division accounts for about 86% of the company's operating income. The Smokeless Products division accounts for about 12.5% of operating income, while the Wine division is responsible for only 1.5% of operating income.

Segment

Revenue

2014 Rev. Growth

Op. Margin

Op. Income

Smokeable Products

$ 21,868

-1.60%

32.30%

$ 7,063

Smokeless Products

$ 1,778

5.10%

57.54%

$ 1,023

Wine

$ 609

8.60%

19.38%

$ 118

Source: Altria 2013 Annual Report

Brand Strength

Altria's well positioned brands have allowed the company to grow despite significant headwinds in the cigarette industry. Altria also owns Parliaments and Virginia Slims cigarettes, and Black & Mild cigars. The company's smokeless Tobacco brands include Copenhagen, Skoal, and Husky. One brand stands above all the rest for Altria: Marlboro. The Marlboro brand has continuously gained market share over the last 60 years

(click to enlarge)
Source: Altria Group Annual Shareholder Meeting Presentation

E-Vapor

The e-vapor market has the potential to propel future revenue and earnings growth for Altria. The e-cigarette market is expected to grow substantially over the next decade, replacing much of the revenue lost from declines in traditional cigarettes. Altria's e-Vapor business is conducted through its Nu Mark Division. The company owns both the MarkTen & Green Smoke brands.

Altria recently acquired Green Smoke for $110 million this year. The acquisition gives Altria a management team experienced in e-vapor, as well as a brand that achieved $40 million in revenue in 2013. To date, Green Smoke has sold over 28 million products. The Green Smoke acquisition is accretive for Altria shareholders because it will propel the future growth of the company's e-vapor products.

Source: Altria Investor Relations

The e-Cigarette market is in its infancy and is still highly fragmented. The big tobacco companies have an unexpected ally in its quest for e-vapor market domination: The US Government.

Increased government regulation of e-vapor products will work in favor of large tobacco companies like Altria as regulation and compliance costs will pose a substantial economic burden to small businesses with less funding than Altria. Altria can reinvest cash flows from the declining cigarette market into marketing and developing high quality e-vapor products.


Source: Wells Fargo Securities

Altria is partnering with Philip Morris International to develop new e-vapor and heated cigarette products. The licensing deal gives Altria authority to sell Philip Morris International's heated tobacco products in the US. Philip Morris International gets the rights to sell Altria's e-vapor products internationally. Altria will benefit from this partnership by receiving royalties from Philip Morris International's sales of e-vapor products globally. Altria also benefits by being able to sell heated tobacco products in the US.

Source: Altria Investor Relations

Altria & Philip Morris International may be different companies now, but they still can benefit from pooling their research and development resources and knowledge to create the next generation of tobacco products.

Shareholder Return

Altria Group's goal is to maintain a long-term average earnings per share growth rate of between 7% and 9%. The company achieved this goal as of late, with a 7.8% EPS CAGR since 2011. Further, the company pays a dividend yield north of 4%. Shareholders of Altria can expect a CAGR of between 11% and 13% going forward, well in excess of expected stock market returns.

Valuation

Altria's real value cannot be calculated properly without considering the company's 27% equity stake in SAB Miller. By subtracting the value of SAB Miller from Altria, you can see the company's real price to earnings ratio as well as the stand-alone value of the company's SAB Miller investment.

The SAB Miller company is worth about $93 billion based on current market cap. Therefore, Altria's 27% share of SAB Miller is worth approximately $25 billion. Over the last 5 years, earnings from Altria's share of SAB Miller has made up about 14% of profits before taxes.

Reducing the company's profits 14%, and subtracting SAB Miller's equity value of $25 billion would give Altria a P/E ratio of 15.95, significantly below the company's current P/E ratio of 19.76.

Altria compares favorably to its peers based on its modified P/E ratio of 15.95.

Ticker

Company

P/E

PM

Philip Morris International, Inc.

17.56

BTI

British American Tobacco plc

17.38

MO

Altria Group Inc.

15.95

RAI

Reynolds American Inc.

21.83

LO

Lorillard, Inc.

20.9

VGR

Vector Group Ltd.

47.5

Source: Finviz

Consecutive Years of Dividend Increases

Altria has increased its dividend 39 consecutive years, excluding the impact of spin-offs. The company's long-streak of dividend increases shows that Altria has a strong competitive advantage in the tobacco industry.

Why it matters: The Dividend Aristocrats (stocks with 25-plus years of rising dividends) have outperformed the S&P 500 over the last 10 years by 2.88 percentage points per year.
Source: S&P 500 Dividend Aristocrats Factsheet, February 28, 2014, page 2

Dividend Yield

Altria has a high dividend yield of 4.50%. The company's high dividend yield is especially attractive in today's low interest rate environment. Altria's dividend yield compares favorably to other businesses with 25+ years of dividend payments without a reduction, ranking as the 6th highest out of 120.

Why it Matters: Stocks with higher dividend yields have historically outperformed stocks with lower dividend yields. The highest-yielding quintile of stocks outperformed the lowest-yielding quintile by 1.76 percentage points per year from 1928 to 2013.
Source: Dividends: A Review of Historical Returns

Payout Ratio

Altria has a high payout ratio of 87.00%. The company's high payout ratio means that dividends cannot increase faster than overall company growth for the future. Dividends may increase at a slower pace than overall company growth if Altria decides to keep its payout ratio at a safer level. Altria compares unfavorably to other businesses with 25+ years of dividend payments without a reduction based on the payout ratio, ranking at 107 out of 120.

Why it Matters: High-yield, low-payout ratio stocks outperformed high-yield, high-payout ratio stocks by 8.2 percentage points per year from 1990 to 2006.
Source: High Yield, Low Payout by Barefoot, Patel, & Yao, page 3

Long-Term Growth Rate

Altria's revenue per share growth rate over the last 5 years has been under 3%. The company's earnings per share growth rate has been much higher due to increasing profit margins and heavy share buybacks. The company's slow revenue per share growth rate compares unfavorably to other businesses with a long history of dividend increases, ranking in at 92 out of 120.

Why it Matters: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4 percentage points per year from 1972 to 2013.
Source: Rising Dividends Fund, Oppenheimer, page 4

Long-Term Volatility

Altria has a fairly low long-term standard deviation of 20.29%. The company's low volatility is due to the recession resistant demand of cigarettes. Altria compares favorably to other businesses with a long history of dividend increases based on this metric, ranking at 21 out of 120.

Why it Matters: The S&P Low Volatility index outperformed the S&P 500 by 2 percentage points per year for the 20-year period ending September 30th, 2011.
Source: Low & Slow Could Win the Race, page 3

Conclusion

Altria is an extremely shareholder friendly business with a long history of dividend payments and substantial share repurchases. The company ranks in the top 50% of businesses with 25+ years of dividend increases based on the 8 Rules of Dividend Investing.

Investors of Altria will experience solid growth if the company can continue to increase profit margins. If not, then shareholders of Altria will still receive strong dividend payments and low single-digit growth.

Source: The Smoking Truth About Altria