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Altria Group (NYSE:MO) is the leading cigarette company in the United States, with its Marlboro brand being the top brand in the country. In 2008 Altria spun off its international operations as Philip Morris International (NYSE:PM), which I wrote about here.

(click to enlarge)MO Chart

MO data by YCharts

Altria currently trades at $33.91 with a hefty 4.84% dividend yield. Here's the ten-year dividend history.

YearDividendGrowth
2002$2.449.91%
2003$2.648.20%
2004$2.826.82%
2005$3.068.51%
2006$3.328.50%
2007$3.05**-8.13%
2008$1.68**-44.92%
2009$1.32**-21.43%
2010$1.4610.61%
2011$1.588.22%

** Years affected by spin offs

In 2007 Altria spun off its majority stake in Kraft Foods (KFT) and in 2008 spun off Philip Morris International, so dividends during those years aren't comparable. Excluding those years the average dividend growth has been about 8.7%, which is extremely high for such a high yield. I'll calculate the payout ratio as a percentage of the free cash flow. The results are shown below.

YearFree Cash Flow (Mil $)Float (Mil Shares)Payout Ratio
2002$8,6032,13160.44%
2003$8,8422,03660.79%
2004$8,9772,06564.87%
2005$8,8542,09172.27%
2006$11,1322,10562.78%
2007$8,8462,11873.03%
2008$4,4602,08775.56%
2009$3,1702,07186.24%
2010$2,5992,079116.79%
2011$3,5082,06492.96%

The payout ratio in recent years has been extremely high, over 100% in 2010. This would suggest that the kind of dividend growth seen in the past will not continue.

Another factor with Altria which is not an issue with spin-off PMI is the threat of increased regulation from the FDA, increased taxation, and decreasing tobacco sales in the US, as illustrated in the graph below. All of these suggest that the dividend growth of the past will not be sustainable.

(click to enlarge)

*MSA - put restrictions on advertising and marketing of cigarettes, among other things

Valuation

I will use the Dividend Discount Model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole.

The bright side of the story is that using just a 3% dividend growth rate yields a fair value of about $32.50, which is close to the current market price.

Conclusion

I think that a 3% dividend growth rate is overly pessimistic, but it proves the point that Altria is at worst fairly valued and at best significantly undervalued from a dividend perspective. Altria is a good dividend stock with a high yield, but I wouldn't expect high dividend growth going forward.

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