Should You Buy Altria For Its Income Prospects?

| About: Altria Group, (MO)

Summary

Altria has an excellent yield and has the scope to raise dividends by at least the same rate as future earnings growth.

It has a robust, defensive profile and benefits from a high degree of customer loyalty towards its dominant Marlboro brand.

Altria also offers strong capital gain potential, with reduced risk products and pricing potential being two positive catalysts on its share price.

With Altria (NYSE: MO) yielding 3.6% versus just 2.3% for the S&P 500, it is of little surprise that it holds relative appeal for income-seeking investors. Furthermore, Altria's dividend is covered 1.23 times by profit and this indicates that the company has sufficient headroom to raise dividends moving forward, especially since Altria is a mature company operating in a mature sector.

As such, its reinvestment needs appear to be fulfilled at the current level of dividend payout and there may even be scope for the payout ratio to increase from the present level of 81% since a number of the company's sector peers have higher payout ratios. For example, Philip Morris has a payout ratio of 91%.

Furthermore, Altria offers a highly defensive earnings profile, with it being a defensive stock due to the wide economic moat which it enjoys. That's at least partly because of the lack of new entrants to the US tobacco market, but also because of the domination which Altria has of the market through its Marlboro brand. This accounts for around 43% of US cigarette sales and means that Altria has a high degree of customer loyalty and relative stability regarding its financial performance. This makes it an idea income stock, since it is more predictable and resilient than many of its S&P 500 peers.

In addition, Altria has a diverse income stream, with it benefiting from a stake in beverages company SABMiller (which is being taken over by AB InBev). Altria is also US-focused and so its earnings are not impacted to the same extent as most of its index peers by currency fluctuations. This provides additional security for its investors since dividends are more predictable and robust compared to a number of its peers.

As well as a defensive profile and healthy yield, Altria also offers upbeat capital gain prospects. A key reason for this is its ability to grow earnings through the development of reduced risk products (RRPs), which we think will act as a positive catalyst on its share price moving forward. Altria has teamed up with Philip Morris to innovate in what could be an exciting space for the tobacco industry as consumers become increasingly health conscious.

And while Altria has exposure to the increasingly lucrative e-cigarette market (which could boost its sales in the long run), we think that its ability to develop a range of RRPs (including Marlboro Heat Sticks) could have an even bigger impact on its share price. With Altria benefiting from the collaboration with Philip Morris in this area, we think that RRPs could be a game changer for Altria's share price moving forward.

Another catalyst to positively impact on Altria's share price is its pricing potential. As mentioned, the domination of the Marlboro brand in the US provides Altria with a high degree of customer loyalty and we think that this provides an opportunity for Altria to be a price leader in terms of raising prices by a larger amount than its competitors. This should provide Altria with higher sales and profitability moving forward and we believe that it could have a positive impact on the company's share price, too.

Clearly, Altria is not without risks. One cloud on the horizon is interest rate rises, with the Fed recently stating that it expects to raise rates twice this year. This could hurt higher yielding stocks since other income-producing assets may become more appealing on a relative basis and Altria's share price could come under a degree of pressure as a result.

Furthermore, Altria's debt levels remain relatively high and while we remain comfortable with the extent of leverage on the company's balance sheet (Altria has a debt to equity ratio of 443%), the market may become less bullish on more highly leveraged companies. In our view, with Altria having the scope to raise prices due to its high degree of customer loyalty, we believe that its margins will remain healthy and that its share price will continue to deliver index-beating capital gains moving forward.

With Altria having a forward P/E ratio of 18.8, it trades on a premium to the S&P 500 which has a forward P/E ratio of 16.7. However, we think that this premium is wholly deserved since Altria has the potential to deliver superior capital gains moving forward owing to its scope to develop RRPs and also increase prices on its key brands such as Marlboro. And with the company's shares having a yield of 3.6% which is well-covered by profit and has the scope to rise by at least as much as earnings over the medium to long term, we remain bullish on Altria's income prospects moving forward.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.