Altria: Wait For A Pullback To $26

| About: Altria Group, (MO)

The cigarette industry had been in the decline in the US over the last few years. However, the ongoing recession has proved to be a boon to the industry as the job and economy related stress has resulted in an increase in tobacco consumption among the population. Much of the government's efforts to discourage smoking by increasing taxes and other levies have largely been ineffective in diminishing the profit margins in the business as volume is being gradually replaced by margins.

In this sector, Altria (NYSE:MO) is not only a large stake holder but also maintains a large budget for advertising and marketing to negate the influence of regulatory and legal battles against tobacco apart from its other diversified business interests. With the imminent revival of the world economy, the company has been chosen for research to ascertain its intrinsic value for investors to invest in.

Altria is a holding company whose wholly owned subsidiaries as of December 31, 2011, include Philip Morris USA (manufacturers of cigarettes and certain smokeless products), UST LLC (manufacture and sale of smokeless products and wine), John Middleton (manufacturer of machine-made large cigars and pipe tobacco) and Philip Morris Capital Corporation (finance leases). In addition, Altria holds a 27% economic and voting interest in SABMiller (second largest brewer in the world by revenue). Hence the group has presence in cigarettes, smokeless products, cigars, wine and financial services, all of which are considered to be the segment of the rich and the influenced.

Tobacco processing is the primary business of the company and it has been attracting adverse attention due to its health hazards. However, it has managed to surprise its analysts with better than expected earnings and profit. The main positive for the company is its extremely low beta of about 0.4 displaying its stability over the years. It has a total market capitalization of about $61.9 billion, making it one of the largest companies within this industry. It also has an extremely high operating margin of almost 38% along with a quarterly revenue growth of almost 5%, making it highly lucrative for its shareholders.

The current EPS of the Altria is about $1.64 which is well below the industry average of $2.40 as well as many of its close competitors. The company is also having a P/E of 18. 54, which is almost equal to the average P/E within the industry. Further, the company has a dividend yield of about $5.30 and a return on equity of about 11.35% against an industry average of 4.03% making it a good option for placing money in for healthy returns.

A comparable company with similar or even better operating margins from the same industry is Lorillard (NYSE:LO). The company has excellent operating margins at almost 46% and has more than a billion dollar as its net income to show for it. It also boasts of an excellent EPS of $7.99 and a lower P/E of 16.42 in comparison to the Altria. However, the company is comparably much smaller having a total market capitalization of only about $17 billion making it much more susceptible to global intolerance of tobacco usages. The company also has a few legal cases in the US courts, especially the one against the FDA over its plans for implementation of health warnings prominently over the product packs. Hence, even though the company is the third largest producer of cigarettes in the US, the stock should be avoided by long term investors due to various regulatory frameworks coming into play.

Another major competitor in this industry for Altria is Reynolds American (NYSE:RAI). It is another major manufacturer of tobacco products in the US and generates a net income in excess of $1.4 billion. The company has a higher EPS of $2.4 and a lower than Altria's P/E ratio at about 17. Though the company has a dividend yield and ROI similar to that of Altria, its net operating margins are substantially lower at about 30% against that of Altria's 38%. Further, the company also lost a case in the US Supreme court recently over compensatory and punitive damages for "conspiring to hide information about dangers from smoking". This opens the floodgates for similar cases and the company may face serious potential losses through such litigations. Hence, investors are better off not investing their money in the second largest cigarette manufacturer of the US.

As far as Altria is concerned, its subsidiary Philip Morris USA has showed good improvement in profitability in spite of the regulatory action against tobacco consumptions. The brand "Marlboro" has surprisingly being growing stronger with new products like "special Blends" and "Marlboro Black" in the market. The cigarette business of the company has captured about 40% of the American market and generates about 80% of their company's revenue. The company also has an impressive ROE of about 76%. It also has the advantage of a diversified business into wine and financial sectors besides diversifying into smokeless tobacco products which are rapidly gaining popularity.

PMCC, the company's finance subsidiary, holds investments in finance leases, power generation and manufacturing equipment and facilities. The financial sector is likely to look up in the coming years given the expected turnaround of the world economy. In the wine segment, it witnessed a tremendous growth especially in premium products apart from large volume of all other products. Further, the company has successfully managed to reduce its costs by $1 billion over the last four years and targets another $400 million by the year 2013, which will further boost its profitability.

The net income of the company is in excess of $3.3 billion per annum with an extremely healthy cash flow of $956 millions thus inferring that the company is likely to show positive growth both for itself as well as for its shareholders in years to come. Further, the company has also been upgraded by Wells Fargo to "outperform" recently. However, going by the current valuations, the stock is trading at a premium and investors are therefore advised to enter only at dips whilst those who are already invested may hold it for a longer period. The company is surely a buy in the range of $26 to $28 for investors who are willing to risk their money to avail some high returns.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.