Altria: Buy The Dip?

| About: Altria Group, (MO)

Summary

Altria is down 10% from its recent highs.

Coupled with its recent dividend raise, this has pushed the yield to nearly 4%.

Is this a buying opportunity?

Altria remains one of my go-to picks among dividend growth stocks.

Few stocks have posted the returns Altria (NYSE:MO) has over the years. The dividend champion has raised its annual dividend for 47 consecutive years, with the most recent increase just last month. However, with the recent share price decline, Altria is approaching the 4% yield mark, a level often seen as a buying opportunity for income focused investors.

Altria has fallen 10%, now yields nearly 4%

After hitting the $70 mark in July, Altria share price has fallen around 10%, a puzzling decline given its strong earnings trend. Earnings, after items, are expected to grow 7-9% this year to a range of $3.01 to $3.07 per share and the 2017 EPS average estimate is $3.33, suggesting 9% growth next year.

Using the 2017 EPS, Altria is trading at a 19x forward PE ratio. This is slightly above the 5-year average, but Altria is also seeing accelerated EPS growth, so a higher PE is warranted.

In addition, the recent decline in the share price has resulted in Altria's dividend yield reaching 3.9%, almost at the crucial 4% mark income investors strive for.

Altria's current 4% yield plus high single digit growth at a 19x PE ratio compares favorably to the peer group. Philip Morris (NYSE:PM), which is growing at a low single digit rate due to forex issues, trades at a similar PE ratio and yields only 30 basis points higher at 4.2%. Reynolds American (NYSE:RAI), has very similar earnings growth to Altria and yields the same 3.9%, though lacks the upside catalysts listed below.

Upside catalysts

Altria's earnings profile also stands to benefit due to several recent developments.

FDA cracks down on online e-cigarettes sales

Regulators are finally paying attention to the fast growing e-cigarettes business. The FDA has issued 24 letters to websites for possible illegal sales to minors and these sites will need to take efforts to prevent future underage sales, which may limit their growth. Anything that hurts e-cigarettes is a positive for Altria, especially volumes, due to its dominance of the "regular" cigarette market.

The SABMiller merger

The Anheuser-Busch InBev (NYSE:BUD)/SABMiller (OTCPK:SBMRY) merger is expected to close later this year and is expected to provide a boost to Altria's earnings profile. Altria will own a 10.5% equity stake in the combined company. BUD has historically grown at a double-digit rate, which is above Altria's. This stake equates provides ~20% of the current earnings. Altria is also getting around $3.0 billion in cash upon closing the deal, which can be used to great effect by lowering debt, as noted below.

Bond buybacks

Another upside catalyst for Altria are its bond buybacks. The company is retiring older, much higher interest, bonds with newer, lower interest, paper. After the BUD merger, the newly issued attained cash can also be used.

For example, Altria announced a cash tender offer for some of its debt. At yields of 9.95% and 10.20% and due 2038 and 2039, this will result in major interest expense savings down the line. Though, this will also result in some large one-time costs this year as Altria will need to pay a 80% premium to entice debtholders to sell.

Dividend growth potential

Lastly, Altria's main attraction is its dividend growth record. The dividend was raised 8% in 2016 and is slated to rise a similar amount next year given the earnings estimates out there.

An 8% dividend growth rate with a near 4% starting yield results in a nearly 6% yield after 5 years, assuming no dividend reinvestment. With dividends reinvested, the yield is above 7%, assuming a stable share price.

In terms of total return, assuming the stock stays at a near 4% yield, Altria would return around 12% per year with no dividend reinvested and around 15% per year with reinvestment.

Conclusion

YTD, Altria is up only 8%, which, while beating the market, still seems low given how well it is performing. The combination of a the high current yield at 4% and dividend growth in the 8% range, offers a compelling picture for both income and total returns investors. Buy the dip? You'll have to do your own due diligence, but Altria appears to be in a good spot at the moment.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

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

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.

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