Altria Group Sells Off On Market Stupidity, Dividend Growth Remains Solid

| About: Altria Group, (MO)

Summary

Altria Group looks solid and the market seems far too concerned by the prospect of regulation.

MO has enough clout to influence the regulation into policies that favor big tobacco over small tobacco.

Larger barriers to entry for vapor products would put smaller companies in a weaker position so Altria Group could make cheaper acquisitions.

Rules that delay widespread vapor use give Altria Group more time to adjust while their smokeable products deliver.

Altria Group (NYSE:MO) sold off on April 13th despite an increase in major market indexes. The decline is widely believed to be the result of concerns around the FDA's potential regulation of the "e-cig" business.

This Reaction is Completely Overblown

This is a very small product line for Altria Group. It does not warrant its own breakout in the company statements and is instead included in the "all other" category. The revenues and operating income from each segment can be seen below. For your convenience, I've placed a green box around the revenues and a yellow box around the resulting operating income:

Click to enlarge

The vapor market, which many investors and analysts seem to believe is the absolute wave of the future, is not yet profitable for Altria Group. While this market does have the potential to grow significantly, there is still substantial research to be done on the relative dangers of the product.

Big Tobacco Has Big Money

Since Altria Group is the very definition of big tobacco in America, it shouldn't be surprising that they would seek to influence the regulation. In previous coverage, I wrote about the impact of the FDA's regulation on Altria Group.

"Doesn't the FDA Hurt Big Tobacco?

It might seem that way, but it would be more accurate to suggest the FDA hurts 'Little Tobacco'. The regulatory burdens created by the FDA are substantially more onerous for the smaller companies that can't afford to buy politicians. I'm sorry; I believe the correct term is 'lobby government'. The laws that actually get passed won't be too harmful to Big Tobacco."

The Potential Regulation

The fear seems to be centered on the idea that vapor products could undergo the same classifications as other tobacco products. Before a new tobacco product can be marketed, it goes through a painful process. For investors that wish to see the path, they can look at the FDA's " Premarket Tobacco Applications" page.

It isn't just my view that FDA regulations would stifle competition dramatically more than they would hurt Altria Group. Wells Fargo provided an update to tell investors that regulation of this sector would likely weaken competition and allow Altria Group to secure a stronger position in the new industry.

Oligopoly's Win

The beautiful thing about Altria Group in this kind of market is that slow growth in the new category is still acceptable. They don't currently have a strong position in vapor products the way they do in both "smokeable" and "smokeless" products so a slower development with more hurdles would allow them to grab more market share and prevent more competitors from making it to market. Instead, those companies unable to cover the heavier costs of regulation could face bankruptcy or be sold to an investor with deeper pockets. The investor with the deepest pockets and substantial knowledge of the regulation process would be, of course, Altria Group. Increasing regulation should make acquisitions easier at lower prices. That is great for investors, since they would rather see Altria Group use their operating cash flows to pay out huge dividends rather than handle capital expenditures or pay premium prices to acquire smaller producers in the vapor category.

Conclusion

Rulings that put a barrier on the production of vapor products create a larger barrier to entry into the sector and increase the odds of an oligopoly forming in the small industry. Small competitors won't have to go out of business, but they won't have much leverage if they are avoiding a bankruptcy by selling themselves (or their brand) to Altria Group. While Altria Group is trading at fairly high levels relative to earnings, the same can be said for the S&P 500 as a whole. Since the broad market includes oil companies that are having their earnings decimated, it seems fair to say Altria Group is better priced than the rest of the domestic market.

I'm contemplating making a small addition to my position in Altria Group on the weakness in the tobacco sector. If regulation allows Altria Group to protect their "smokeable" product category while delaying the vapor category until they can get a stronger grip on the sector by buying competitors that are struggling under the weight of new regulation, that sounds like another brilliant way for Altria Group to keep the expenses low and the dividends high.

Disclosure: I am/we are long MO.

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.

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