Why I Own Altria

Jul.11.08 | About: Altria Group, (MO)

PM USA estimates that total cigarette industry volume declined approximately 4% in the first quarter. For the full-year 2008, PM USA estimates a total cigarette industry volume decline of approximately 3%.

Altria Group’s (NYSE:MO) tobacco manufacturing and distribution business, PM USA expects this trend to continue, with industry shipment volume declining 2.5% - 3.0% annually over the next few years.

So, why would anyone own Altria Group?

I do, and here’s why:

Altria dominates the U.S. tobacco industry with powerful brand names. The company has a commanding 50.9% share of the cigarette retail market. Marlboro boasts a 41.5% share. Acquired last December, John Middleton placed Altria in a leading position in the machine-made large cigar market with a 26.8% share. Middleton’s key Black & Mild brand controls 25.9% of that market.

Altria has a fortress balance sheet with lots of cash and low debt. The company ended this year’s first quarter with $4.8 billion in cash and cash equivalents, and long-term debt as a percentage of total capital of 13.5%.

Altria has always been and still is a cash machine. Right out of the box post spin-off the company delivered free cash flow of $1.9 billion in the first quarter.

Management is implementing a strategy that should support earnings growth in a shrinking market. The strategy calls for: cutting expenses at rates that exceed declines in cigarette volume; growing market share; and extending product lines and leveraging distribution through acquisitions and internally developed products.

Here’s how the company is performing so far:

  1. Management plans to slice $1 billion out of the company’s cost structure by 2011. Selling, general and administrative expenses will drop by $600 million. Corporate headquarters functions have been restructured, including the relocation to Richmond, Virginia from New York, and should yield annual savings of $250 million starting next year. Another $156 million will come from the closing of the Cabarrus, North Carolina manufacturing facility and subsequent consolidation with the Richmond, Virginia facility by 2010.
  2. Market share grew in the first quarter from a year ago. The company’s share of the cigarette retail market gained 0.5% on the back of Marlboro’s 0.7% increase.
  3. John Middleton is in a segment of the industry that’s growing 4% - 5% per year. Middleton posted a first quarter volume gain of 8.2% with Black & Mild increasing its market share by 3 points.
  4. New products have not worked out so well. Marlboro Ultra Smooth, a high tech filter cigarette, was recently pulled from the marketplace due to low acceptance. Other failures include a cigarette with a battery-powered holder to heat the tobacco, and a spit free chewing tobacco. I believe that shareholders would be better served if management would abandon this part of their strategy and redeploy these resources on what they know and already are doing best.
  5. Altria has started 2008 with a solid earnings performance. Earnings per share  (adjusted for one-time items and from continuing operations) came in at $0.37 in the first quarter, up 12.1% from the same year earlier period on a 2.8% gain in net revenues. Management affirmed their forecast for 2008 earnings per share at $1.63 - $1.67, for an increase of 9% - 11% off of a 2007 base of $1.50, and set an objective of growing earnings 8% - 10% over the next few years. Projections by Street analysts are at the high end of these ranges.

Altria has a 28.6% ownership interest in SABMiller, the world’s largest brewer. At the end of the first quarter, Altria’s investment in SABMiller was carried on the books at $4.1 billion and had a recent market value of nearly $10 billion.

The company is returning cash to shareholders. The Board of Directors set the initial quarterly dividend at $0.29 per share, and is targeting a 75% payout ratio. They also approved a $7.5 billion share repurchase program to be completed over 2 years. The company began buying back shares in April.

Altria’s shares are attractively valued with a price / earnings ratio and yield that compare favorably with the S & P 500. The shares’ price / earnings ratio, at 12.9x 2008 earnings per share of $1.63, is below the S & P 500’s 14.5x based on S & P’s earnings estimate of $88.04 for this year. The shares also offer a fat 5.5% yield, well above the S & P 500’s 2.4%.

Disclosure: I own Altria