If you read Altria (MO) articles/comment streams on Seeking Alpha, you’ll come across the common theme of contributors and readers alike (for the most part) highlighting the fact that MO’s management team is one of the best around. This management team has generated massive wealth for MO shareholders over the long term. These gains during tough times (MO has faced fairly constant regulation headwinds throughout the last several decades) have given investors confidence when it comes to MO's management. So, with this in mind, I think it’s fair to give MO’s leadership the benefit of the doubt when it comes to recent acquisitions.
MO has been very active in the M&A space during the last couple of weeks, announcing acquisitions of significant stakes in a marijuana company as well as a vaping company. These moves were made in an attempt to diversify MO’s revenue stream, and frankly put, I love it.
A couple of weeks back, MO took a $1.8B stake in Cronos (CRON). This move gave it a 45% stake in the company with an option to buy another 10% in the future. I don’t follow the marijuana space closely so I can’t really express the pros and cons of the CRON purchase relative to other alternatives in the space, but once again, my bullish outlook on the moves comes from the fact that I trust MO's management and I can only assume that they did their due diligence when it came to CRON vs. pot peers and the fact that I’m bullish on the pot industry as a whole, so the way I see it, any exposure here is better than no exposure.
MO will have the right to nominate individuals for 4 board seats and I can only assume that MO’s marketing/sales team and cash flows will be a nice resource for their new partner in the pot space as CRON attempts to grow and take market share globally. I think that any company that MO partnered with would immediately become a dominate player in the burgeoning industry. During a recent conference call, MO noted that “Cronos will be one of the best capitalized cannabinoid businesses, which we expect will allow them to accelerate their strategies to achieve global leadership in the Cannabis industry.”
More recently, MO made bigger headwinds announcing a $12.8B investment in private company JUUL, which is well known for its ~70% market share in the vaping space. In short, JUUL crushed MO (and the rest of the competition) domestically when it came to vaping. This is a classic, “if you can’t beat them, use your superior cash flows and buy them” situation. And you know what? I’m happy with that. Some people might call it desperate. Others might say it's defensive. Semantics aside, I’m just happy MO now has exposure to two potentially strong growth trends.
MO shares have sold off in response to this move due to rising debt loads, regulatory fears (regarding JUUL’s products, not the actual deal itself), and thought by certain investors and analysts alike regarding the potential desperate nature of this move.
I have to admit that it is rare to see a big company like MO enter into an agreement to buy such a significant stake of a young company like JUUL without a clear path to control. In the deal that MO struck, JUUL remains in control and it doesn’t appear that MO has a clear path changing that. The deal is a long-term move for MO, which isn’t allowed to sell shares for 6 years. MO has committed towards helping JUUL with logistics and marketing, which should help the latter grow and, therefore, increase the value of MO’s stake. It is also speculated that MO will use its longstanding lobby power in Washington and lawyers who’re well versed in the anti-tobacco fight to aid JUUL in its current issues revolving around underage use.
In the press release sent out by MO, management highlighted the benefits for its long-term shareholders, saying:
"We are taking significant action to prepare for a future where adult smokers overwhelmingly choose non-combustible products over cigarettes by investing $12.8 billion in JUUL, a world leader in switching adult smokers. We have long said that providing adult smokers with superior, satisfying products with the potential to reduce harm is the best way to achieve tobacco harm reduction. Through JUUL, we are making the biggest investment in our history to achieve that goal. We strongly believe that working with JUUL to accelerate its mission will have long-term benefits for adult smokers and our shareholders."
Source: JUUL press release
In its press release, JUUL acknowledged the “counterintuitive” nature of the partnership, highlighting the fact that its products are the reason for MO’s recent growth issues. JUUL said:
- Switching data shows that almost 50% of smokers who purchase JUUL switch from combustible cigarettes within 90 days.
- Cigarette decline rates in the US are at record levels with the last 2 months demonstrating decline rates at almost 3x the previous 3-year average. The single most important driver of this decline is JUUL's growth.
Source: JUUL press release
Honestly, the tone of the JUUL press release came across as a bit rebellious to me. Management made it seem like they still wanted to keep their distance from their new investor (due to MO’s tobacco background), yet I’m sure that they are quite happy to now have JUUL marketing slips being included in MO cigarette packaging. I’m also sure that the MO partnership will help JUUL with shelf space is various outlets.
And on the slip side, the JUUL stake now gives MO a better international foothold (where it can potentially market/sell cannabis products as they become legal via its Cronos stake). I think the combination of JUUL, Cronos, and Altria’s logistics/marketing division will make for a powerhouse in the CBD vaping space (I imagine this will be a popular way to consume the oils if/when they’re legalized domestically). At the moment, a lot of the growth potential surrounding this deal is speculative because recreational marijuana is not yet legal in the U.S.; however, I have to imagine that it is only a matter of time before this changes. When it does, MO will now be in a great position to capitalize and I’m happy to see that as a shareholder.
The $1.8B that MO spent to acquire a position in CRON is relatively small compared to this company’s cash flows. During the trailing 12 months, MO has generated $7.3B in operational cash flows and $7.1B of free cash flow. Right now, MO’s annual dividend payments are expected to cost just a tad bit more than $6B annually. This leaves ~$1.15B of free cash flow to cover interest rate expenses and pay down debt annually. MO's management also touched upon the fact that it hopes to cut costs to the tune of $500M or so per year in response to the debt additions to the balance sheet. Assuming they’re able to hit these targets, it will help them reduce debt to pre-acquisition levels over the next decade or so.
There are some concerns that MO overpaid for JUUL. The deal that Altria made placed a $38B valuation on JUUL. That’s pretty massive for a company that is so young and is facing such strong opposition from legislative headwinds. Some people in our nation’s capitol see JUUL as the figurehead of the growing epidemic of vaping in the American youth. I would have thought that this political pressure might have lowered the premium that MO was forced to pay for JUUL (and heck, maybe it did, though $38B is a much higher valuation than the $16B valuation that it was given when it was raising funds last summer).
These fears of overpaying for assets led to two analyst downgrades on Friday. Citi downgraded MO to a sell, cutting its price target from $67 to $45, citing its opinion that the JUUL investment is destroying shareholder value. JPMorgan maintained MO at equal weight with a $54 price target, though its analyst, Pamela Kaufman also noted the lofty premium that MO paid for its stake in JUUL. And lastly, Stifel Nicolaus analyst Christopher Growe cut his price target from $70 to $54.
Regardless, of all this negative attention, I’d much rather see MO be proactive and gobble up market share via M&A than sit back and be beaten. Furthermore, it’s fairly obvious that cigarette volumes are going to continue to decline. I’m not sure why analysts are just not realizing this and reducing their targets from such lofty prices. I was selling when MO was trading at $70 too. At those levels, the valuation simply didn’t make sense. It’s worth noting that the cigarette slump is a slow bleed. I think MO had to make moves to diversify itself now while it still has strong combustible tobacco related cash flows, rather than waiting until the gig was up. I’m glad it did and I think the analysts are overshooting to the downside (just like they did to the upside prior).
And before I move on to value oriented data, I think it’s important to note that MO investors gained a bit more exposure to the pot market, albeit indirectly, via MO’s ~10% stake in Anheuser-Busch InBev (BUD), which announced a partnership with Tilray (NASDAQ:TLRY) earlier in the week. While there isn’t any equity being swapped in this partnership, the two companies are working together to research non-alcoholic THC & CBD infused beverages. I suspect that if this research is productive, the partnership could open a door to an acquisition (either full or partial), though that is obviously speculative at this point. Either way, BUD’s activity in the space seems to further legitimize MO’s recent investment in Cronos and points towards more activity amongst the consumer packaged goods, food and beverage, alcohol/tobacco, cosmetic, and pharma names in the pot space. Needless to say, I suspect to see a gold rush (green rush, if you will) by mature, cash cow type companies looking for growth and I’m happy to own names like Altria and Constellation Brands (STZ) which have been proactive.
While I wait for these deals to be accretive to MO’s earnings, I still get paid a hefty dividend. After MO’s recent sell-off to the $49 range, the company’s shares yield ~6.5%. Honestly, this seems crazy to me. I remember writing articles about selling MO shares a year and a half ago when they were yielding ~3.3%. At the time, I said that the risk/reward associated with the valuation and the yield that I received in turn was not worth it. Well, flash forward 18 months and the yield on MO shares has basically doubled due to a couple of large dividend increases combined with share price weakness and now I think the risk/reward looks attractive.
Right now, MO trades for ~12.7x TTM earnings. This is the lowest valuation associated with MO shares in 8 years or so. Looking ahead, these shares are even cheaper. Using average analyst estimates for 2019 EPS, MO shares are currently trading with a 11.5x forward earnings.
Granted, MO just announced that its 2019 EPS growth will likely be below its long-term 7-9% growth targets due to interest rate expenses associated with the ~$15B of debt that the recent acquisitions have added to the balance sheet (MO recently took out a $14.6B term loan). Conservatively, I think a 5% bottom line growth target makes sense for MO next year. So, instead of the $4.35 that analysts currently estimate for 2019 EPS, I’m expecting the figure to come in somewhere closer to the $4.20 range. Even so, that represents an 11.9x forward earnings multiple. I’m quite happy to pay that for a company offering a relatively safe 6.25% yield (when I was writing bearish articles on MO 18 months ago, shares were trading with multiples above 20x).
Looking a bit further out, we see that the current average analyst estimate for 2020 EPS is $4.63. This is essentially in line with management’s previous guidance of annual growth in the high single-digit range. However, I’m going to go ahead and put a 5% growth target on 2020 EPS as well (MO will still be burdened with higher debt loads and will likely have to dedicated excess funds to deleveraging instead of buybacks, which might have otherwise bolstered he EPS) which brings us to a $4.41 target for 2020 EPS. That points to an even cheaper, 11.4x multiple looking ahead a couple of years. All in all, this stock seems attractive from a valuation standpoint.
I’ve stayed true to the old value oriented manta: buy when there is blood in the streets. Altria's shares are now down more than 32% from 52-week highs. I’ve been buying recently as they fall, with purchases at $54.27, $54.23, and $48.89. For years I’ve been waiting for MO to diversify into pot and now that it has, I’ve been happy to buy. Thankfully, the market seems to dislike the moves, so I’ve been able to buy at a discount (even better!). Because of the recession additions, MO has climbed into the top 10 largest holdings in my portfolio.
Right now, MO sits at #8 for me, at 2.79% of my portfolio. MO is now my second largest income producer, behind only AT&T (T). In 2019, MO is currently projected to generate 6.9% of my portfolio’s passive income. I’d be happy to add again if MO shares fall to the $45 area, which would mean a dividend yield of more than 7%. Time will tell if the market’s sentiment shifts, but I’m happy to stash cash in MO shares sporting a 6.5% yield and trading with near single-digit multiples.
Disclosure: I am/we are long T, MO, STZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.