Here's Why I Am Seriously Considering Selling My Altria Stock To Buy Chevron

| About: Altria Group, (MO)
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Summary

Altria is very aggressively valued considering its poor earnings this year. This has pushed down its dividend yield to rarely-seen lows.

By comparison, Chevron is very cheap on a valuation basis due to the decline in oil, but its earnings are not as bad as its stock performance implies.

The end result is that Altria and Chevron offer similar dividend yields, which hasn't happened in the past ten years.

This is a unique opportunity to swap a stock with low earnings potential for a company that I believe has much better fundamentals, without losing income.

First and foremost, I am an income investor. When I started buying individual stocks several years ago, I did so with the stated goal of creating an income machine. My ultimate objective in portfolio management is to retire early and live off the dividend income from my investments. I make most investment decisions with that specific goal in mind.

Tobacco giant Altria Group (NYSE:MO) was one of the first stocks I purchased in my Roth IRA. I loved the extremely high dividend yield offered during the financial crisis. I was able to scoop up shares with a dividend yield in excess of 6%. But those days are long gone. Altria has produced such huge stock price appreciation that its dividend yield is now at multi-year lows. My yield on cost is high, but the low current yield means my dividends are not being reinvested at favorable yields. By comparison, a stock that has not performed well is integrated energy giant Chevron (NYSE:CVX). Chevron is being beaten down by the carnage rippling through the oil market, but this is a very strong company from a fundamentals perspective.

It might seem like both stocks are struggling to grow earnings, which is true on the surface. However, it's important to note the context of what is happening right now. Chevron's earnings are suffering from the inevitable cyclicality of the oil markets. I do not believe the long-term price of oil will remain at $60 per barrel in the United States. By comparison, Altria's earnings are down because of a more concerning structural problem, which is that its customer numbers are shrinking with each passing year. This sets up a very attractive opportunity to swap out a company I believe has a dim long-term future for a stock I believe to be a fantastic bargain.

A once-in-a-decade opportunity

Altria has always been a higher-yield dividend stock, and Chevron a higher dividend-growth stock. That is, until this year. Altria has rallied considerably in stock price, up 31% year-to-date, which has pushed its dividend yield down considerably. And at the same time, the continued collapse in oil prices has sent Chevron's stock price down 14% so far in 2014. The end result is that Chevron and Altria both yield 4.1% right now. This is the first time in the last ten years that Chevron's yield has matched Altria's, which is a very rare scenario. In fact, Altria's dividend yield is usually several hundred basis points above Chevron's. In 2010, for example, Altria yielded over 6% while Chevron yielded below 3.5%.

Although I've been very impressed with the share price gain on my Altria investment over the past few years, Altria's poor fundamentals are a significant concern. I'm a fundamental analyst at heart. I place a lot of weight on a company's revenue and earnings growth, not just its stock price performance. Altria sustained a 3.5% drop in smoking volumes for its Philip Morris USA division over the first nine months of the year. Revenue and earnings per share are down 0.1% and 4.5%, respectively, in this period. Altria management forecasts 3%-4% annual declines in cigarette volumes, and plans to make up for this with price increases to drive revenue growth and cost cuts to drive earnings growth. But these are not viable long-term solutions. At some point, you can't keep raising prices on an increasingly smaller group of customers.

Another worrisome fact is that despite what some investors believe, Altria really doesn't have a diversified business. Investors see its stake in SAB Miller (OTC:SBMXY) and wine business as diversification, but the truth is that smokable products still make up 90% of Altria's profits. These businesses are too inconsequential to save Altria from the risk of a long-term decline in smoking.

To be sure, Chevron's earnings are ugly right now too, but the company is faring relatively well thanks to its strong business model. Net income is down just 4% through the first nine months of the year. While it's undoubtedly true that its upstream exploration and production activities are hurting due to oil's dramatic decline, its integrated structure is providing valuable insurance. Earnings in Chevron's downstream business, which includes refining, are up 52% over the first three quarters. Downstream usually does better when oil prices decline, because pricing spreads typically increase, which leads to higher margins and profits. And, once oil recovers, Chevron will be a major beneficiary.

Chevron is very cheap right now, trading for just 12 times forward EPS estimates. By comparison, Altria trades for 18 times forward earnings, which is a rich multiple for a company with questionable long-term earnings growth. I believe Chevron will produce better earnings, higher dividend growth, and more total return potential as well, over the next several years.

Waiting to pull the trigger

There are a couple of reasons why I have not pulled the trigger on this stock swap just yet. First is that I think the fallout in the oil market may have further room to go as 2014 draws to a close. I want to wait for tax-loss selling to run its course. While I wholeheartedly believe Chevron is too cheap, a cheap stock can always get a little cheaper, and I think Chevron might make its way below $100 per share in the next few weeks. Plus, Altria is due to pay its next quarterly dividend soon, which I plan to capture. The ex-dividend date for Altria's upcoming quarterly dividend is December 22 and the record date is December 24. I plan to hold Altria at least through this period to receive this dividend payment. Once the new year approaches and I book Altria's dividend, I will strongly consider selling Altria and buying Chevron.

Disclosure: The author is long MO.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.