Is there any more loved stock than Altria (MO)? While the previous company, Philip Morris, was a global company that at different times operated an international food and smoking business, including what is today called Kraft (KFT) and Philip Morris International (PM), the company today gets over 80% of its revenues from the domestic cigarette business.
While each of these stocks has held-up well during the recent sell-off, it is interesting to look at the performance and current valuation of many leading dividend stocks, such as Altria, Kraft, Procter & Gamble (PG), and AT&T (T). While each of these companies is distinct in their own way, all of these companies are projected have single digit growth moving forward, are yielding close to or more than 4%, and are in businesses that are not cyclical.
Indeed, while the S&P 500, and its tracking exchange traded fund, SPY (SPY), has rallied over 15% since the summer lows of last year, and market leaders such as Apple (AAPL) are up over 30% this year, dividend stocks have outperformed most sectors and the broader indexes by a fairly wide margin over the last several months.
What is interesting to me about the leading dividend stocks in most exchange and mutual funds, is that each of these companies is trading at a similar multiple of around 15x next year's likely earnings despite analyst projections calling for mid-single digit growth rates over the next 3-5 years.
Given that each of these companies has a similar valuation and projected growth rate, and Altria and its precursor, Philip Morris, is one of if not the most widely held dividend stocks in the history of the stock market, I think it is interesting to see how grossly overvalued this company has become.
I've advocated investing in the tobacco industry frequently over the last 2 years, with my first article recommending Lorillard (LO) in the 70s, and I recently recommended companies such as Altria, in the high 20s, late last year.
Altria is a nearly $70 billion dollar company trading at 20x trailing earnings and 14-15x average earnings estimates for next year. The company has just over 50% of the U.S. tobacco market, a 25% position in SAB Miller, and owns the St. Michelle Wine brand as well as smokeless and chewing tobacco brand Skool and Copenhagen. The company also owns John Middleton cigar brand. Altria gets over 80% of its revenue today from its cigarette business.
Altria recently reported redefined adjusted earnings that were up around 5-6% year-over-year. Still, the company's net income has dropped for five consecutive quarters, and Altria has consistently reported dropping cigarette shipment for several years.
Altria's net income has dropped three straight years, and five straight quarters, but the company's stock has nearly doubled in the last three years, and the stock up over 15% this year alone. Indeed, investor demand for yield is so strong, individuals have been willing to invest in this company over the last three years without looking at how the company is raising its dividend. Today, Altria's debt to equity ratio is over 300%, and the company's coverage of interest payments has deteriorated since 2010. The company's current coverage of interest payments is around 6, which is poor, and Altria's long-term bonds trade at around 8%, suggesting a modest rise in treasury yields would make future capital significantly more expensive.
Altria's payout ratio is listed at 80%, but since the company's net income is considerably less than its actual earnings, the company is really paying out 100% of its total income in dividends. The company is also borrowing to maintain its buyback program.
Essentially, Altria is continuing to leverage its balance sheet while the company's earnings continue to deteriorate, and the company continues to borrow at artificially cheap rates to increase its dividend, which has grown by nearly 30% in the last 3 years while the company's net income has consistently declined. Altria is valued at 20x trailing earnings, which is a growth multiple, even though the company's net income has consistently been negative.
Obviously, sometimes companies have one time charges that affect earnings per share for a particular quarter or year, but Altria's net income is declining primarily because of litigation costs. Considering the significant and continued litigation costs this company has had over a multitude of decades, its not clear to me why management would not include a consistent annual cost in the company's earnings per share.
To conclude, cheap capital and artificially low rates have made many consumer staple companies with strong yields very appealing. Still, the recent rally in many of these leading stocks have been based on unsustainable increases in debt, not any significant growth in actual income. While many leading consumer staples names have been the best performers in the market over the last several years, past performance is not always the best predictor of future results.