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Altria Group (NYSE:MO) is a cigarette manufacturer and producer of alcoholic beverages in the United States.

The community sentiment is overly pessimistic toward Altria based on declining sales due to anti-smoking campaigns and taxation that artificially inflates the price of cigarettes and, hence, reduces consumption and sales. Even though this is a very logical and consistent argument, the company valuation based on earnings is not that high.

Altria has one of the highest dividend yields in the sector with 4.7% and produces tons of free cash flow, $3.3 billion, that both backs dividend payments and capex that is required to find growth in other segments. Philip Morris (NYSE:PM) on the other hand offers only 3.4% with a free cash flow of $9 billion and a lower net profit margin (14% for Altria compared with 12% for Philip Morris).

Bears should also consider that Altria just broke through the upper bound of the short-term trend canal - on low average volume. The recent increase in price is not driven by momentum traders or caused by some one-time non-recurring news event: The stock marches steadily higher. Given that bears seem to be in the majority, I have initiated a personal short-term long position via Calls to profit from increased interest in Altria stock.

With an operating margin of 26% and a return on investment of 11% the company has shown that worries over pressure on the cost structure due to declining sales are overblown. The company is still profitable even though I confess there is room for improvement. Specifically, the company will need to move into other areas to explore growth and free cash flow.

Altria stock is trading not that unreasonable as some investors on this forum want you to believe: The shares quote at 14x forward earnings, which is a level where I cannot identify an overpricing. Free cash flow, dividends and earnings multiple look very decent.

I have a 2013 EPS estimate of $2.60 on the stock. Applying a multiple of 16 would yield an intrinsic value of $41.6, which still represents about 20% upside from current values. The volume levels do not indicate that the stock is overbought, so I am going to ride this wave a little longer. The overwhelming bearish attitudes toward Altria almost make this investment a contrarian play.

Disclosure: I am long MO.

Source: Altria Is Still Grossly Undervalued And Has Upside Of 20%