3 Reasons We're Bullish On Altria

| About: Altria Group, (MO)

Summary

Altria has excellent defensive characteristics which could make it popular at a time when uncertainty is high in the wider market.

Altria has a high and fast-growing dividend which may prove popular among investors with the Federal Reserve adopting a dovish stance.

E-cigarettes and other reduced risk products (RRPs) could also positively catalyse Altria’s share price through increasing its profitability.

Right now, stocks are headed for their sixth straight day of declines. The S&P 500 has fallen by 2.4 % during that period and that's despite the Federal Reserve holding interest rates at the current level. It seems as though investors are worried about the outlook for global economic growth and this plays into the hands of Altria (NYSE: MO), in our view.

That's because Altria has superb defensive characteristics and we believe that they will act as a positive catalyst to allow the company to outperform the S&P 500. It has already done so during the last six trading sessions, with Altria's share price rising by 0.5% during that period. And with further uncertainty yet to come, we believe that Altria is well-placed to beat the wider index.

A key reason for this is Altria's highly resilient business model. Its earnings are less positively correlated to the performance of the wider economy than is the case for most of its index peers and this means that they are likely to grow whether the US or global economy performs well or not. That's because demand for tobacco remains relatively stable during even the most challenging of economic periods and with Altria also having its stake in SABMiller (soon to be part of AB InBev), its sales and profit outlook is well-diversified and even more robust.

In our view, this could be a major ally for investors and we feel they will be willing to pay a greater premium for that privilege. Therefore, Altria's defensive appeal during an uncertain period for the market could act as a positive catalyst on its share price.

With interest rates being kept at 0.25%-0.5%, we think that income stocks such as Altria are also likely to remain popular among investors. While investors had expected there to be multiple interest rate rises in 2016, it now appears as though there may be relatively few. This could increase demand among investors for higher yielding stocks and with Altria currently yielding 3.5%, we think that its high headline yield could act as a positive catalyst on its share price and push it higher.

With the S&P 500 yielding just 2.2%, Altria has a yield which is almost 60% higher than the wider index. And with its payout ratio standing at under 80%, we think there is scope for Altria's dividends per share to rise at a faster pace than is the case for the wider index.

That's particularly the case since Altria is forecast to increase its earnings by 10.5% in the current financial year and by an additional 8.8% in the next financial year. In our view this growing bottom line and rising dividend could be another positive catalyst to improve investor sentiment and push Altria's share price higher. And with Altria having such a robust earnings profile (as mentioned), the chances of it making those forecasts seems to be higher than is the case for the majority of its S&P 500 index peers.

Of course, there is much more to Altria than defensive appeal and a high, fast-growing dividend. In fact, we believe that Altria's biggest potential catalyst is its exposure to the reduced risk products (RRPs) space. Altria has invested heavily in a joint programme with Philip Morris to develop new products which deliver nicotine to the user but which are potentially less harmful than using traditional tobacco products.

One example of a successful RRP is e-cigarettes and although we think that there is much more growth to come in this space which Altria can tap into, we think that a wave of new RRPs is set to become available to consumers over the medium to long term which could stimulate sales and profit growth for companies such as Altria. For example, Marlboro HeatSticks could muscle in on the popularity of e-cigarettes and with Altria sharing the cost and risk of development with Philip Morris, we believe it is in a strong position to deliver high growth. This, we feel, could act as a very positive catalyst on Altria's share price.

In terms of the growth prospects of RRPs and the potential size of the market both in the US and for Altria specifically, forecasts suggest a positive outcome for Altria. The current size of the US tobacco market by sales is around $80bn and the e-cigarette market is worth around $2.5bn. However, the latter is growing quickly and by 2019, vapor device sales are expected to equate to around 16% of total tobacco sales. This means they could be worth as much as $13bn and with Altria having a quarter of the US tobacco market, its sales from e-cigarettes could be over $3bn. This fits in with forecasts made by Philip Morris, which believes that a market share of 10-15% of the tobacco market within 5-10 years would not be unreasonable for RRPs.

As such, while cigarette volumes are falling, a five-fold increase in RRPs sales could boost Altria's top and bottom lines and make it less reliant on price rises in the cigarette space. And while e-cigarettes are already proving popular and are set to become even more so, the $80bn US tobacco market offers the scope to introduce new and innovative RRPS (such as HeatSticks) over the long run. Due to Altria's combination with Philip Morris, it seems to be well-placed to benefit from this tailwind.

So, while the last six trading sessions have been disappointing for the S&P 500, we remain bullish on Altria's prospects. Its mix of defensive qualities, a high and growing dividend, as well as the potential for upbeat growth due to RRPs could act as positive catalysts on its share price, which is why we are long Altria.

Sources

"Philip Morris International aims for 'reduced risk' products," CNBC.

"What Do Smokers Really Want: E-Cigarettes, or Safer Tobacco?" The Wall Street Journal.

"Tobacco in the US," Euromonitor International.

"Economic Facts About U.S. Tobacco Production and Use," Centers for Disease Control and Prevention.

"Market Share Leaders," The Tobacco Atlas.

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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.