Altria: Stock Valuations Are Set To Expand

| About: Altria Group, (MO)

Summary

Company is making correct strategic decisions to strengthen its product portfolio to support revenue growth.

Alternate tobacco products will bode well for revenue and earnings growth in the long-term.

Stock is trading at a forward P/E of 19.5x, in comparison to its peers average P/E of 20.5x.

Altria (NYSE:MO) is the leading U.S. tobacco company, with a market share of 51%. MO has been delivering healthy financial performance, and the momentum is expected to continue in the upcoming quarters. The company is making aggressive efforts to solidify its product portfolio by focusing developing e-cigarettes, which will help it to offset sales volume pressure from traditional cigarettes and will fuel future growth. As the company will continue to develop and expand distribution of its e-cigarettes, its risk profile and business fundamentals will improve, which will result in the stock valuation expansion. The stock's current valuation remains attractive as it is trading at a forward P/E of 19.5x, in comparison to its peers average P/E of 20.5x. Moreover, the company has a strong cash flow generation, which supports its share buyback program and an attractive dividend yield of 3.4%.

Financial Performance and Growth Catalysts

Tobacco companies have been facing sales volume pressure due to strict regulations and increasing health concerns among consumers. The U.S. tobacco sales volumes are expected to decline by 4% annually, according to Moody's. However, I believe, MO's sales volume decline will be less than that of the industry, as the company has strong and diversified product portfolio. In the challenging industry conditions, the company is relying on price increases, cost cuts and development of alternate tobacco products to fuel its growth. The company reported healthy performance for 2Q16; revenues for the quarter came out to be $6.5 billion, in-line with analysts' estimates. Also, EPS increased to $0.84 for 2Q16, from $0.74 in 2Q15. MO's performance for the quarter was positively affected by price increases and productivity gains. And given the strong performance in the first half of 2016, MO raised its EPS growth target from 7%-9% to 7.5%-9.5% for 2016.

As the revenue growth is challenged due to decline in sales volume, the company is aggressively working to reduce its costs and improve productivity. MO has a target to cut expenses by $300 million annually by the end of 2017, which will not only result in profit margin expansion but also allow the company to reinvest cost savings to support its product innovation efforts and fuel long-term growth. Also, the company can increase its marketing and advertisement spending in the upcoming quarters to back its flagship brand 'Marlboro' sales volumes, as Marlboro sales volumes were weak in 2Q16; Marlboro sales volume were down 5.5% in the quarter.

Furthermore, the company's efforts to strengthen its product portfolio, especially by development and expansion of its e-cigarettes (MarkTen) will positively affect its future performance. In the U.S., e-cigarette device sales are forecasted to increase by five-fold and will represent 16% of the total tobacco value sales by 2019. MO is positioned well to take advantage of the growing e- cigarette sales, as it is expanding distribution of MarkTen XL; MarkTen is now available in 50% of e-vapor stores in mainstream retail channels. Moreover, MO is working with Philip Morris (NYSE:PM) to develop heated tobacco products. The partnership to develop heated tobacco products will strengthen MO's product portfolio and allow it to take advantage of PM's next generation product's initiatives; PM has spent more than $2 billion in R&D of next generation products from 2008 until 2015. The success of MO's alternate tobacco products will drive the stock valuation expansion, as the company's profit margin will improve; alternative tobacco products generate higher profit margin in comparison to traditional cigarettes. Also, lower regulatory pressures will improve the business risk profile.

Moreover, the company will continue to share its success with its shareholders in the form of cash returns, which are backed by its strong cash flow generation. The stock offers a solid dividend yield of 3.4%, and its dividend growth will improve in the upcoming quarters, as investment behind alternate tobacco product will start to pay off. Also, in the second half of 2016, MO targets to accelerate the pace of share buybacks, which will bode well for its EPS growth.

Summation

In the challenging industry environment, the company is making correct strategic decisions to strengthen its product portfolio to support its revenues, and to reduce costs to support capital investment and expand margins. The success of MO's alternate tobacco products will bode well for its business, as its revenue growth and profit margins will improve, which will drive the stock valuation expansion. The stock's current valuation stays attractive despite 16% YTD increase in the stock price; the stock is trading at a forward P/E of 19.5x, in comparison to its peers average P/E of 20.5x.

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.