The Market Goes Up In Smoke, But Altria Group Stands Tall

| About: Altria Group, (MO)

Summary

MO is in a great position as three factors come together to support the company.

Brexit is driving up the value of the dollar and threatening the earnings of companies with international operations.

The falling yield on treasury securities sends investors seeking a secure source of income.

Regulatory pressure on e-cigs creates burdens for smaller competitors.

Altria Group (NYSE:MO) is enjoying a great rally as several factors work together to help it thoroughly smash the S&P 500. The major factors lately have to do with Brexit. MO benefits relative to most other equity investments in a few ways. Perhaps the most obvious is that after the hectic trading action following Brexit most traders could use a smoke. You think it is something else? Alright, time to dig a little deeper.

Domestic Sales

While the S&P 500 has a great number of "domestic" companies that make a huge portion of their revenues from selling products overseas, Altria Group is handling domestic sales. The punishment for international exposure is demonstrated by Philip Morris International (NYSE:PM), which was down 4.5% so far (this is written before the market closes) compared to 3.67% for the S&P 500. Even being down 4.5% isn't so bad for Philip Morris compared to the international ETFs. The Schwab International Equity ETF (NYSEARCA:SCHF) was down 7.95% at the time of writing and was one of the biggest loss drivers in my portfolio despite a very small allocation.

Because Altria Group is selling their products domestically the influence of a change in the currency exchange rate is pretty much nothing. That allows Altria Group to outperform when the strength of the dollar is threatening to weigh on results for companies with international operations.

As shown below, the dollar was up about 2% around 3:15 EDT:

Click to enlarge

Yield Replacement

Investors that weren't holding treasury bonds prior to the Brexit event are now suffering even more as they search for yield. While Altria Group's P/E ratio may be seen as very high relative to past levels for the tobacco giant, the dividends have been solid for decades. If investors are emphasizing getting a solid dividend yield and maintain a solid "buy and hold" mindset, then the dividend income from Altria Group became even more valuable.

Impact of Regulation

If you haven't heard about it yet, there have been some disgruntled smaller companies in the industry. At least one of them was so disgruntled they decided to file a lawsuit. Legal cases aren't free, so this is another burden on the competition while Altria Group doesn't even have to fund a defense since they are not the defendant.

New rules on compliance for e-cigs lead to an estimate of $20 million in compliance costs per product. For smaller tobacco companies, the lack of economies of scale is an absolute disaster. For Altria Group, this simply smashes their competition.

I predicted this back in January, when I wrote:

"Recently I made the decision to buy shares in Altria Group. I believe Altria Group offers investors access to an excellent position in the consumer staples space. Their products are addictive and MO is the behemoth of the industry. If investors want to understand why MO is capable of delivering growth year after year, the answer may lie in regulatory capture.

Does Altria Group Like the FDA?

For investors that aren't familiar with the concept of regulatory capture, it would seem like the FDA would be a perpetual thorn to MO. However, MO encourages regulation:

I believe MO is being very candid when they say they support the FDA extending regulatory authority. I believe they genuinely support the FDA's regulation over the sector. Why would they want the FDA to extend more authority? Because they genuinely see the FDA as a friend.

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. When the rules are being written, Altria Group gets a seat at the table."

Can you imagine a better situation for big tobacco? They can encourage regulation, influence the regulation, and watch new laws come into place to protect their market. Small companies seeking to compete are stuck either paying for lawyers, paying for compliance costs, or possibly paying both. Meanwhile, Altria Group simply spreads the cost across a much larger volume of products sold and can shrug it off.

Net earnings to Altria Group last year were $5.24 billion. $20 million doesn't even tickle their profit line; it is merely a rounding error.

Conclusion

Altria Group was able to dramatically outperform the domestic market because it combined the benefits of consumers seeking a source of relatively secure income with the benefits of selling products domestically so that the strong dollar wouldn't hammer away at earnings. The fundamentals of the company remain solid as their friend (the FDA) prepares the regulations that drag down smaller companies that would have nibbled away at MO's profits.

If you need a way to feel ethically justified while investing in big tobacco, there are plenty of arguments that can be made. Perhaps the best one right now is that Altria Group's influence is creating larger hurdles to companies that would seek to drive down the cost of tobacco products. By keeping the cost of tobacco high, Altria Group is creating a barrier to smoking. Think that's a weak argument? Then do what I do, collect the dividends and call it a day.

Disclosure: I am/we are long PM, MO, SCHF.

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.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.