Wow, Altria (MO) sure is a popular stock. Today, even though the S&P 500 and the SPY (SPY) -- as well as market leaders like Apple (AAPL) -- are up over 50%, Altria and other consumer staple names have outperformed most of the broader indexes during the last three years.
Still, no matter how strong a company's business model is, when a company growing its revenues by mid-single digits is up over 50% in such a short time span it usually is a good time to at least reevaluate the size of your investment in that stock.
So what's the problem with Altria, and why should a company that has given investors such great returns over so many decades be sold today? What if I told you that a company was borrowing at 8% to raise its dividend by 9%? Would you want to invest in that company?
To me, the main reason long-term investors should avoid or sell their positions in Altria today is because of how overleveraged the company's balance sheet has become. While Altria acquired UST for around $10 billion several years ago, the company was forced pay around 8% to finance the acquisition. The high price at which Altria was forced to finance that deal was primarily the result of the acquisition being timed right before the credit crunch. While this acquisition has been somewhat accretive to the company's earnings in the short term, the real cost of continuing to finance the deal at 8% is yet to be seen.
Additionally, many of Altria's long-term bonds are already trading at around 8% today, which is likely one of the main reasons why the company has continually resisted attempts to spin off its sizable position in SAB Miller (SAB.L).
Another big danger sign to me is, when looking at Altria's nearly $14 billion in long-term debt the company is generally paying between 7% and 9% to service, that the company's 80% payout model gives management little flexibility if the company wants to maintain and continue to increase its dividend.
The question is: If Altria's business model is that successful at generating cash, why is management not calling some of the longer-term bonds trading at yields over 8% in today's more favorable borrowing environment? The answer is that Altria simply doesn't have the cash flow to maintain or increase its dividend while effectively servicing the company's debt. Why else would a company with an 80% payout ratio that is only raising its dividend by around 8%-9% a year be continually extending its nearly $1 billion credit line?
While Altria's latest $1 billion buyback plan is in essence similar to a debt reduction effort, since the effort to return shareholder value obviously reduces the long-term dividends the company will pay out, the question remains: Why is Altria paying 8% on any bond when it claims to be such a cash cow? I think questions regarding the company's long-term revenue growth are worth asking. Today, Altria gets most of its revenue growth from price increases and cost-reduction efforts. While the company's market share has stabilized for its flagship brand Marlboro, at around 42%, Altria makes up about 50% of the U.S. tobacco market and is continually shipping fewer cigarettes each year. According to the company's first-quarter earnings report, Altria shipped nearly 4% fewer cigarettes in 2011.
Today Altria's shares have an appealing 5% yield and the company can borrow at favorable short-term rates because of how artificially low rates are. Altria's cost reduction program and price increases are also generally offsetting the company's continually declining cigarette shipment numbers. Longer term, though, the company is not likely going to be able to rely on price increases and cost-reduction efforts to continue to grow its revenues.
As rising interest rates will likely eventually make the 10-year treasury yield around what Altria's stock is yielding today, the company will could soon be faced with higher borrowing costs and shrinking revenues at a time when investor demand for the stock is much lower than such demand is today. So where will Altria's dividend and share price head in the next couple years? I think the answer to that question in the near term is anyone's guess. Still, the appeal of higher-yielding companies in a low-rate environment, today, is unique.
As rates and inflationary expectations will likely begin to move up in the coming years, investor demand for stocks like Altria will likely diminish from today's levels by a moderate to significant amount. If Altria needs to refinance debt or do a secondary offering in an environment where rates and inflation are rising, current investors will likely be the ones most hurt by the company's increasing difficulty to finance its heavy debt load.