Tobacco stocks like Altria Group (NYSE:MO) are well-known and extremely well-regarded for their income potential. Altria has been one of the premier dividend stocks to own over the past several decades. It has a remarkable ability to pay a high yield, and also provide regular dividend increases that have significantly increased shareholder wealth over this time. To that end, Altria very recently increased its dividend by 8%, representing the 48th dividend raise in the past 45 years.
Today, however, many investors and analysts fret about Altria's ability to keep growing. This is because of the declining smoking rate in the United States. As the bear case contends, it's illogical to view Altria's past as prologue, because the growth rates it achieved for the past several decades won't be possible going forward.
This may be true, but only to a point. Rest assured that Altria management is fully aware of the increasingly harsh public view of tobacco. In short, Altria has a plan.
The wonders of pricing power
As Altria revealed in a recent investor presentation during its annual shareholder meeting, that its long-term objective is to grow adjusted earnings by 7%-9% every year. This might seem difficult, since smoking is on the decline in the United States.
But Altria isn't concerned. It fully expects a 3%-4% annual decline in smokers. Management intends to counteract this with regular pricing increases. Since Altria's Marlboro brand is the dominant product and holds an iron-clad grip on market share, it can pass along regular price increases to offset most of the decline in the number of smokers overall.
Plus, management is counting on new innovations to produce revenue growth.
New product categories and a diversified business
First and foremost, e-cigs present a compelling future catalyst. The e-cig category is rapidly growing, and Altria is building a formidable position there. Altria is rolling out its MarkTen product nationally, and believes the "four draw" technology separates it from the competition. To supplement its position, Altria also acquired Green Smoke's e-vapor business for $110 million.
Next, Altria points to its other brands as sources for growth. It has a successful smokeless business through the Copenhagen and Skoal brands. Collectively, Altria's smokeless segment has now become a $1 billion business by operating profit. Operating profits of smokeless products increased 7% last year.
Separately, Altria's significant voting stake in SAB Miller also boosts earnings.
Cost savings and buybacks
Earnings per share growth should be further accomplished through two other separate initiatives: cost savings and share repurchases.
Altria produced $400 million in cost savings last year. Going forward, it recently restructured some of its debt, to take advantage of the low interest rate environment we're currently in. Late last year, Altria bought back $2.1 billion in existing debt and sold $3.2 billion in new, lower-cost debt that will effectively reduce interest expense. Altria's weighted average coupon interest rate dropped from 7.2% at the end of 2012 to 5.9% at the end of last year.
Plus, Altria is aggressively buying back its own shares. Between 2011 and 2013, Altria repurchased $3 billion worth of shares. Even better, the company recently announced a brand new $1 billion share repurchase authorization. This will help reduce the number of shares outstanding, and boost EPS.
To conclude, it's fair to say that the declining smoking rate does present a limit on future growth. But it's not realistic to think that Altria management doesn't fully know that this is happening. Altria has diversified its business in recent years, and there are future catalysts that can keep sales growth intact. Primarily, these include pricing increases, and new product categories such as e-cigs.
Combined with modest expense reductions, Altria should have no trouble generating earnings growth in the mid-single digit range. Considering Altria vows to distribute at least 80% of its adjusted earnings as dividend payments, investors should realistically expect 6%-8% annual dividend increases for the foreseeable future.
Disclosure: The author is long MO.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.