Is Altria Overvalued By The Market?

| About: Altria Group, (MO)

Summary

With my article, I want to propose my valuation of the stock.

I will use the EPS growth capitalization method to assess Altria.

Altria looks overvalued by the market.

I have been reading some articles about the valuation of Altria Group Inc. (NYSE:MO). With my article, I want to propose the following valuation of the stock.

I will determine the intrinsic value of this stock using EPS growth capitalization. According to this method, we first forecast the future stock price of MO let's say in 5 years time and then we discount it to determine the intrinsic value of the stock. The intrinsic value represents what the stock is worth today, that compared with its current share price, will tell us whether the stock is overvalued or undervalued by the stock market.

To protect himself from the risk of inaccuracies in the calculation, the investor usually applies a margin of safety to the discounted value.

Calculating Altria's future EPS:

The first step of the EPS growth capitalization method is determining the future EPS and the future P/E ratio in 5 years' time. To determine the first figure, I need to apply a compounded growth rate to the future stock price for a total of 5 years.

As you can see from the picture below, the Growth Estimate in the next 5 years (per annum) of Altria Group Inc. is 8.20%.

Source: Yahoo Finance

In the case of Altria, the growth rate of 8.20% is justified by the fact that Altria operates in a highly consolidated industry and together with Reynolds American Inc. and Lorillard Tobacco Company, LLC (privately held), they set high barriers to entry.

Altria markets Marlboro, which is the best-selling brand of cigarettes in the USA. And with SABMiller (OTCPK:SBMRY) that will be part of AB InBev (NYSE:BUD) for $104B, Altria's business model will be even more diversified. The company already has the most diverse business model among its U.S. peers.

With almost $3.8 billion in cash and cash equivalents on hand with no short-term borrowings, there is plenty of cash for buyback programs.

The EPS (2015) of Altria Group Inc. is $2.80 and considering a growth rate of 8.20%, my determination of EPS (2020) is calculated as follows

EPS (2020) = $2.80 (1 + 8.20%) ^5;

EPS (2020) = $4.15

Estimating the future P/E:

Now I need to estimate the future P/E that is P/E in five years' time or P/E (2020). The below graphic shows avg P/E from 2006 to 2015:

Click to enlarge

Source

I will determine the trend line of P/E values from 2006 to 2015, and then I will extrapolate the P/E in 2020 and I will use it as a future P/E.

Year PE

T

y=Y-avg Y

t=T - avgT

yt

T^2

Trend Value

2006

16,5

1

0,1

-4,5

-0,45

20,25

13,18

2007

18,25

2

1,85

-3,5

-6,475

12,25

13,90

2008

10

3

-6,4

-2,5

16

6,25

14,61

2009

13

4

-3,4

-1,5

5,1

2,25

15,33

2010

13

5

-3,4

-0,5

1,7

0,25

16,04

2011

18,5

6

2,1

0,5

1,05

0,25

16,76

2012

15

7

-1,4

1,5

-2,1

2,25

17,47

2013

14,75

8

-1,65

2,5

-4,125

6,25

18,19

2014

23

9

6,6

3,5

23,1

12,25

18,90

2015

22

10

5,6

4,5

25,2

20,25

19,62

avg Y and avg T

16,4

5,5

59

82,5

Beta

0,715

Alfa

16,4

T t=T - avgT Trend Value

11

5,5

2016E

20,33

12

6,5

2017E

21,05

13

7,5

2018E

21,76

14

8,5

2019E

22,48

15

9,5

2020E

23,19

Click to enlarge

The average yearly P/E over the period 2006 to 2015 is 16.4 with an average yearly increase of 0.72t.

The equation of the trend of the P/E (yearly data) over the period from 2006 to 2015 is:

Tt = 16.4 + 0.72* t;

Then I will replace t in the linear equation with the values of the t = T - Tavg (see the table above), to get the trend of the P/E and to extrapolate the trend values from 2016 until 2020.

The trend value of P/E in correspondence with year 2020 is 23.19. I will use this value as the future P/E that is P/E in 2020.

The price of Altria in 5 years and its intrinsic value:

The second step of the EPS growth capitalization method is determining the future stock price of Altria Group and its intrinsic value. I can calculate the future stock price of MO as follows:

P = EPS (2020) x P/E (2020): $4.15 x $23.19 = $96.24 in 5 years' time.

To be able to compare this future price with the current stock price, I need to discount the value according to a discount rate. As a discount rate, I will use the cost of capital of the tobacco industry that is 11.82%. Here you can find cost of capital rates for each industry.

To calculate the intrinsic value of MO, I use the following formula:

P = [Future stock price / (1 + 11.82%) ^5];

P = [$96.24 / (1 + 11.82%) ^5] = $55.05.

On June 24, 2016, Altria Group, Inc. closed at $67.02 per share. The 52-week high is $68.00 and the 52-week low is $47.41. A volume of 16,288,077 shares were traded on the New York Stock Exchange on the waves of the news that GB leaves the EU.

My point of view:

According to my valuation, the stock looks overvalued by the market and 5 out of 10 analysts recommend buying this stock:

Click to enlarge

If my valuation is correct, today, you may buy a stock that will generate a capital gain of about 45% instead of 75% in 5 years, assuming that the investor will sell the stock in 5 years.

Then why don't you consider to invest in the gold mining stock industry, for example, which is set to rally in the coming 5 years. Even considering Altria's dividend yield of 3.59%, if you invest in the gold stock industry taking into account the seasonality tendencies in the metal and gold stocks industry, you will likely outpace the total return on Altria's stock investment. Bear in mind that my idea is based on a time horizon of five years. Furthermore, the Brexit exit will force Janet Yellen and the Fed to defer rate hikes for the balance of 2016, contributing to inflationary pressure that revives gold's long-standing reputation as an inflation hedge.

For investors who already hold this stock:

As of today, five analysts recommend to hold this stock. There are some strong points an investor should keep in mind when holding and staying long on this company with stable growth: Altria dominates the US tobacco market. Marlboro is the best-selling brand of cigarettes in the USA (and in the world). It has the most diverse business model among its U.S. peers.

Altria Group Inc. has an average dividend yield of 3.59% vs. 2.24% of the industry. The company is a faithful issuer of a safe dividend and with almost $3.8 billion in cash and cash equivalents on hand with no short-term borrowings, there is plenty of cash to pay dividends and for buyback programs.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.