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Summary

  • We focus on the income potential of tobacco company, Altria, in this article.
  • Specifically, we look at its payout ratio, yield, earnings growth potential and valuation.
  • We also compare it to a key sector peer from an income investors’ standpoint.

In this article we're taking a close look at tobacco play, Altria (NYSE:MO), from the perspective of an income-seeking investor. Clearly, tobacco stocks such as Altria are well-known for their attractive yield, but we think it could be a good idea to revisit the company and see whether it still stacks up as an income play. We also compare it to sector peer, Philip Morris (NYSE:PM), to see whether Altria is a more attractive option for investors seeking a strong dividend yield.

Current yield

Altria's current forward yield of 4.7% is hugely impressive. Indeed, with interest rates remaining at historic lows, it provides the perfect tonic to investors' income woes. Furthermore, interest rates are set to stay low for a little while yet and, in addition, the Fed seems very relaxed about the pace at which they will rise over the medium term. So, Altria's 4.7% yield should remain attractive for a good while yet -- especially when the S&P 500's yield is just 1.9%. Although also impressive, Philip Morris has a slightly lower forward yield than Altria of 4.6%, which means that if you were to base your decision on this metric alone (as many investors do), you would likely purchase Altria over Philip Morris.

Payout ratio

However, we think there's much more to income stocks than their present yields. For example, while Altria's forward yield is 100 basis points higher than that of Philip Morris, it also has a substantially higher payout ratio than its rival. While Philip Morris pays out 75% of profit as a dividend, Altria pays out 88%. For us, this appears to be a little on the high side, since although Altria undoubtedly has super-strong cash flow, it will need to replace and reinvest in plant and machinery going forward. So, we think that there is little scope for an increase in Altria's payout ratio moving forward, which limits its ability to grow dividends per share to the earnings growth rate (more on that later).

Meanwhile, Philip Morris could increase its payout ratio. For example, if it were to pay out the same proportion of profit as a dividend as Altria does, it would equate to dividends per share of $4.54, which would mean that shares trade on a forward yield of 5.3% at current prices. Clearly, that's substantially higher than Altria's 4.7% forward yield, which tells us that Altria could struggle to keep up with its sector peer in terms of dividend growth in future years.

Earnings growth

Of course, Altria's strong growth prospects for 2014 are already taken into account when considering the forward yield. So, while the market is anticipating the company to report earnings that are 19% higher year-on-year for 2014, the forward yield already accommodates this impressive rate of growth. Likewise, Philip Morris' lack of growth in 2014 (earnings are expected to increase by just 0.2% year-on-year) is already factored into the forward yield.

With regards to next year, Altria's earnings are all set to increase by 7.4%, which means that the company has the scope to increase dividends per share at a brisk pace, too. However, Altria seems unable to match Philip Morris on this front, as it looks to bounce back from a disappointing 2014 with earnings growth of 8.3%. This means that, while Altria's dividend could move higher as a result of strong earnings growth in 2015, Philip Morris seems to have more scope to increase payouts to shareholders over the short term owing to its higher earnings growth forecasts.

Valuation

In our view, Altria currently offers great value for the money. It trades on a forward P/E of 15.5 (which is lower than the S&P 500's forward P/E of 16.8), while its EV/EBITDA ratio is also highly appealing at 11.3. As a result, we feel that it remains a strong income play that trades at an attractive price. Indeed, there is little to choose between the two stocks when it comes to valuation, with Philip Morris having an identical EV/EBITDA ratio to Altria and having a forward P/E that is only slightly lower at 15.2. As such, there is little to choose between the two companies on the valuation front, with them both offering excellent value for the money -- especially when their impressive income and growth prospects are taken into account.

Conclusion

Although we believe that Altria remains a hugely appealing income stock, we think it loses out to Philip Morris on two fronts -- both of which could make a sizable difference to investors' income prospects. Firstly, it has a much higher payout ratio -- 88% versus 75% for Philip Morris. We think this could make dividend per share growth considerably lower at Altria than for Philip Morris over the medium term. Secondly, the earnings growth potential at Altria in 2015 is slightly behind that of Philip Morris (7.4% versus 8.3% for Philip Morris), so we think that there is (again) less scope for dividend per share increases at Altria than there is at Philip Morris. As such, we think that while Altria is still a super income stock, it is not quite as super as sector rival, Philip Morris.

Source: Is Altria Still A Super Income Stock?