Is Now The Perfect Time To Buy Altria?

| About: Altria Group, (MO)

Summary

Altria has easily beaten the S&P 500 in the last year, but we think there is more outperformance to come.

The strength of the Marlboro brand and the pricing potential it brings will be a key catalyst on Altria’s profitability and share price in our view.

We also think that opportunities in reduced risk products (RRPs) and Altria’s dividend potential will positively catalyse its share price moving forward.

With Altria (NYSE: MO) having risen by ten times more than the S&P 500 in the last year, many investors may feel that it is due a pullback. After all, Altria is up by 21% versus just 2.1% for the S&P 500 and investors sitting on a tidy profit could begin to sell and look elsewhere for alpha.

However, we think that there is further upside in Altria's share price moving forward, with these three catalysts set to positively impact on its earnings and share price.

Dividend appeal

With the Federal Reserve having failed to raise interest rates in 2016, it is clear that they are adopting a more dovish stance than the market anticipated. Looking ahead, the Fed is forecast to raise interest rates just once in the next twelve months to 0.75%. This means that higher yielding stocks such as Altria should remain highly popular among investors and even though Altria's share price has risen significantly in the last year, it still yields 3.4% versus 2.1% for the S&P. We think that there is scope for Altria's yield to compress even further and that its income appeal will act as a positive catalyst on investor sentiment and its share price.

Further, Altria has bright dividend growth prospects. It has a payout ratio of 78% and given its stable business model and resilient earnings profile, we believe that this could be increased substantially. For example, sector peer Philip Morris has a payout ratio of 98% and while we are not suggesting that Altria's payout ratio will move to that level, it is clear that tobacco companies have scope to pay out a major portion of profit as a dividend due to their robust earnings visibility. And with Altria also having a 10.5% stake in the SABMiller/AB InBev combination, we think that its risk profile is even lower than that of Philip Morris and this means that Altria's payout ratio could move higher, boost dividends and act as a positive catalyst on its share price.

Brand strength

We think that Altria's share price could also move higher because of its scope to raise prices in response to falling cigarette volumes. With Altria-owned Marlboro being the top selling cigarette brand in the US since 1972 and dominating the market with a 44% share of sales, we think that it has an exceptionally loyal customer base who will be willing to pay a greater premium than at present.

Further, the Marlboro brand is the 26 th most valuable brand in the world according to Forbes, which provides further evidence of Altria's pricing potential. This means that the price elasticity of demand for Marlboro cigarettes is likely to be even more negative than for any other brand, which bodes well for Altria's margins. This potential for higher sales and profitability could act as a positive catalyst on investor sentiment and boost Altria's share price moving forward.

Product innovation

Although some investors view Altria's operating environment as challenging, we think that it holds significant opportunity. Sure, cigarette volumes are declining in the US and the proportion of adults who smoke is also falling, but at least some of this is due to the increasing popularity of reduced risk products (RRPs) such as e-cigarettes. In our view, RRPs hold huge growth potential for Altria since they mean that the proportion of adults in the US who use nicotine-based products (whether cigarettes or RRPs) will stabilise over the medium to long term, since the health incentive of quitting completely (as is the case with cigarettes) will be less strong for users of RRPs.

Further, with Altria having teamed up with Philip Morris on the development of RRPs, we think that it is well placed to stay ahead of the curve on RRP development versus sector peers. That's because the joint resources of the two companies are significant and with there being a lack of rivalry between them in terms of Altria operating in a different geographical location to Philip Morris, we think that the partnership will be successful. And with new RRPs on the horizon such as Marlboro HeatSticks, we feel that they will positively catalyse Altria's earnings and share price moving forward.

Looking ahead

Clearly, Altria's tobacco operation lacks geographical diversity and some investors may see this as a major risk. That's especially the case since regulations in the US are continuing to increase and with the proportion of US adults who smoke falling from 21% ten years ago to 17% today, it could be argued that Altria's operating environment is becoming more difficult.

However, Altria's 10.5% stake in SABMiller/AB InBev provides it with exposure to non-US markets and in any case, with the US dollar expected to strengthen versus a basket of world currencies, Altria could avoid the negative currency effect which internationally-focused index peers may suffer from in future. In addition, we think that the three positive catalysts of a bright dividend outlook, RRP development and the pricing potential offered by the Marlboro brand will mean that Altria's earnings and share price will be positively catalysed and that it will continue to beat the S&P 500 moving forward. This makes now the perfect time to buy it in our view.

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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.