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Altria: Good Valuation Can't Offset Long-Term Decline

Jun. 01, 2020 1:20 PM ETAltria Group, Inc. (MO)98 Comments
Value Kicker profile picture
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  • Cigarette industry volumes to decline by 4-6%. Smoking was the lowest among young people. COVID could accelerate this trend further.
  • JUUL and Cronos were losing investments. IQOS might be successful but would ultimately result in lower revenue.
  • The company is trading at a good valuation, forward P/E ratio of 8.8 with a yield of 8.9%. However, the long-term industry decline plus high leverage make this an avoid.

I’ve discussed the over-all headwinds faced by the smoking industry world-wide in a previous article. Given my negative view on smoking trends overall, I wanted to see if there was a short opportunity / put option opportunity for Altria (NYSE:MO). I didn’t think sister company Philipp Morris (PM) was worth a short position however I view Altria to be in a much weaker position strategically.

As many of you are well-aware, Altria is the manufacturer and distributor of Marlboro and other popular cigarette brands and cigarette alternatives in the US. The company has a dominant share of the US cigarette industry with a roughly 50% market share (dominated by Marlboro which has a 43% market share).

Investor presentation

Unfortunately for Altria, smoking rates in the US continue to decline. Looking at the latest study conducted by the CDC regarding smoking demographics in the US, we can see that cigarette smoking was lowest among people aged 18-24 years at 7.8%. The company says it expects cigarette industry volumes to decline by 4-6% in 2020. (Note: This forecast was before the coronavirus pandemic).

Despite the respiratory disease-related pandemic currently affecting everyone worldwide, I believe that smoking rates and habits wouldn’t necessarily change in the short-term. Smoking is a highly addictive substance whose health risk is already well-known. This is reflected in the Q1 2020 results. Net revenue grew was higher by 15% compared to the same period last year at $5.0 billion and EPS was up 38% to $0.83.

Despite the upbeat results in Q1 2020, in the long-term, I believe that the coronavirus would result in less smoking over-all worldwide due to changes in consumer preferences. This is especially true for the US as young consumers' attitudes were already trending in that direction. This will only exacerbate the trend previously seen trend.

This article was written by

Value Kicker profile picture
Nine to 5 by day. Hobbyist stock trader by night. I got an MBA and a CFA ... so that should count for something. I only care about my own greedy interests and I love feeding trolls. Not your financial advisor. Information for entertainment purposes only. Diamond hands are forever.

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Comments (98)

Retired Securities Attorney profile picture
Baa humbug!
bengalesq profile picture
Altria: Good Valuation Can't Offset Long-Term Decline
Yes it can. If I am not holding it for the next 30 years then yes. Yes it definitely can.
WelshWB profile picture
@Value Kicker

Why Altria is a good quality investment for the long term?

A slightly cryptic answer but if you examine the economics of oil, steel, corn and sugar industry I think you may find the reasons why Altria is a good investment.
BALTOM profile picture
Can you please elaborate?
WelshWB profile picture

If I use steel as an example. In 1901 US Steel had a market cap of $1.4 billion and controlled 67% of the domestic steel market. In 1901 the USA steel market was only 11 million tonne in volume. By 2000s the USA steel market grew to 88 million tonne.

However this growth in volume didn't benefit US Steel in fact it introduced more competition.

Most people fail to ask themselves how much competition exists in an industry and will exist in an industry in the future. Hypothetically speaking if US Steel managed to maintain its market share and profit levels to 1901 level its market cap should have been around $400 billion dollar. But thanks to competition the only winners of the USA steel industry is the construction industry as steel price is rock bottom.

The most important thing you should ask about a profitable company is will it have a future competition?
I never smoked anything. But I am long MO, PM, BTI Legal MJ could happen in the not too distant future. MO will buy all of JUUL at some point. Then MO and PM will merge once the kinks are worked out.
Ta0 profile picture
if that happens, then MOPM will be my largest holding. 😁
Gerard Kaman profile picture
With BUD and POT farms on the side and vaping which will continue I see nothing to worry about.
I find it intellectually dishonest to fault Altria for its long term debt, while completely ignoring the 10% stake in BUD.

Also no mention of Altria's long history of price increases to offset volume declines.
Value Kicker profile picture
Thanks for the comment.

BUD's dividends are included in Altria's cashflow as the company uses the equity method of accounting. Bud's income is included in Altria's IS.

I suppose they could sell BUD to pay down debt. But why just Bud? What about the wine company or the other non-Marlboro brands? Doing so will result in a smaller company and less Income /CF. We'd have to run the numbers again.
Ta0 profile picture
@Value Kicker
They could also buy more $BUD. That way, I don't have to hold both sin stocks, just the one $MO.
arthur_bishop1972 profile picture
@Value Kicker BUD is worth a $hit-ton more than the others, but i'm hoping they unload it next year.
long mo (for the third time) @ $35 to $38. getting 9% + in dividends. sold dec 45's on half my position for $1.15 so making additional monies with the covered calls. juul disaster, cronos problems resulted is a hit but at least willard is gone. watching and waiting for upcomings quarterly reports and divy increases. if you see mo over 45 late this year will revisit the valuation issue but like my position as stated. mo is my largest position
Hypothetical question: Imagine you had rightfully anticipated the mentioned consumer shift away from fat in the 60s, would you have avoided an investment in MC Donalds based on the same logic?
Retired Securities Attorney profile picture
[A person giving up smoking to use JUUL...]
Cigarette smokers are addicted to the nicotine in tobacco. JUUL has no nicotine. No one is going to give up smoking to use JUUL.
Quitting smoking (cold turkey) was the hardest thing I ever did. As my wife stepped on the brake upon our arrival in Las Vegas from New York I threw what was left of my pack of Marlboros out the window into a trash bucket and never smoked again.
@retired securities attorney

What?? No nicotine in JUUL?
Value Kicker profile picture
@Retired Securities Attorney JUUL actually has a TON of nicotine. Congrats on quitting. Not easy.
Nicotine alone is pretty benign. It is however extremely addictive. As it does lift mood. It also improves 'thinking'. As stimulants generally do.

Congrats on stopping. But this of course is no justification to take choice from other Americans. Especially if they are vaping nicotine rather than using combustibles.

It is drug dealers abusing the delivery system. Not the delivery system.
Well done. But I think there is a need to recognize the heft and ability of MO distribution and channel management. Which plays into pot and booze. No question vaping is the nicotine delivery system of youth.

Tawm is correct too. Tobacco was expert at subverting government with settlement fig and tax revenue. In fact, government hostility to far less damaging vaping can only be explained by corrupt politicians protecting their vig.

There was no problem with the Juul system. It was rather drug dealers abusing their system. Which the politicians could jump on and blame Juul. The key to vaping is figuring out how to insure state and especially local governments still get their vig.

The only moral issues I have is the pot. Fine if people wish to grow it for themselves. But putting all this marketing and channel management behind a product which disrupts mental function for a month was never wise. Fine for spent old hippies. But not young people.

Artificially increasing the price with taxes simply kept the Mexican drug cartels in the business.
Why all the claimed tax receipts never materialized.

At this point MO is so cheap and free cash generation so massive it can absorb Juul type loses. If in the end it figures out the political angles to the vaping industry. MO just needs to get it right once to dominate vaping - just like combustibles.

This is not amazon distribution. It is point of sale like gas station retail. Customers who live more in the moment.

I believe this is a chance for investors to add a massive secure dividend. I agree with the Morningstar analyst that it is about 30% undervalued. Juul and all. Plus this does not include the high probability that MO in time dominates vaping and pot markets.

Markets are made of opinions. Your logic is sound. Just different conclusions.

Thank you for the analysis.
arthur_bishop1972 profile picture
How do you figure all the other would-be MJ players (incl the gubmint) are simply going to allow MO to control trade/sales??

I've yet to hear a logical, practical scenario where this could/would occur. And I'm talking about a multi billion dollar industry here-not selling joints in a green and black and white box.
sanchovia profile picture
Beautiful. Jusy beautiful.
Well that would be simply because you underestimate the advantages of scale, distribution, deep pockets and marketing. I have yet to read a cogent practical scenario where MO will not dominate this markets.

I can remember all the same things being said of Microsoft. But with relentless and ruthless strategy MSFT came to dominate software. Finally integrated standardized and secure software platforms provides the key advantage to drive cloud dominance.

Yes, genergic black label is a big part of this industry. The delusional big gains in tax revenues provide the Mexican slaver/drug lords the room to be the low cost provider.

MO came to dominate combustible nicotine. All the competitive advantages which enable dominance are applicable to the highly fragmented pot and vaping markets.

MO just lost billions on Juul. But even so, their superior competitive position remains undiminished. Just delayed. It is MO's market to lose. Juul is the reason analysts now doubt management can execute. Despite the key competitive advantages.
As the country heads into a severe recession - and depression for some economic sectors - cheap, guilty pleasures like smoking will return. Unless the government decides to torpedo the industry like they did to coal, but my bet is they need the tax revenue.
thebucketshop profile picture
I appreciate the bear article. We have seen too many bullish articles recently.

MO is in very unique place right now. The stock recently yielded over 9%. I went to old SEC filings to find out what happened when it last yielded 9%. That was in 1999. This is what happened. The news was particularly bad.

- MO had recently settled the MSA with the states for $250B over 25 years. (MO had a large portion of this claim responsibility, not all of it - est. $90B.)
- MO indicated that price increases over time would fund the MSA.
- MO initiated a huge price increase across the board for combustibles in the US that resulted in 27% increase in revenue.
- MO USA tobacco volume dropped 8%, Intl dropped 7%.
- MO mentioned that customers in 1999 pantry loaded due to the year 2000 date bug (really true!)
- MO in 1998 cut back on share buybacks in anticipation of the MSA.

My question for the readers is: given this information would you have thought this would be a good investment or not? The compounded annual investment return from that period to today was over 16%/year.
Peter Jaworowski profile picture
Yes, thank you for the comment. That’s the kind of thought provoking comments that make this website worthwhile.
I tend to agree that over the last 2 years pretty much that could have possibly gone wrong for Altria, did go wrong.
No return so far from either Cronos or JUUL.
BUD dividends have been reduced twice.
Smoking decline has accelerated.
Balance sheet isn’t quite as good as it was before the Cronos and JUUL deals.

But, I believe there is hope...

ON Tobacco pouches
More marijuana investments? They could continue to acquire assets for pennies on the dollar compared to what they already invested in Cronos.
Better performance out of BUD. Maybe increase their stake since the BUD share price is also depressed.
Finally get JUUL going, and potentially buy the rest of it for pennies or JUUL gets shut down, but that also temporarily helps the cigarette business and maybe reopens the door for a merger with PM since the impression I got last year was PM didn’t want the legal headache JUUL presented.
You mention plenty of decent points and I see why you came to your conclusion but personally I disagree. In my opinion markets are underpaying for large existing profits that are stable while overpaying for future growth that might not happen. That is understandable if the next ten years is to have the sort of S and P 500 performance of the last ten. But personally I don't think that will be the case. I think it is going to be hard to find good profits in the US over the next five years as the promised growth stories start to falter. Under these circumstances Altria's solid dividend becomes much more desirable regardless of growth.

As these dividends become more desirable I don't think the competition in the dividend field is very strong. The vast bulk of dividend payers either have tiny dividends, or debts they can never clear or some huge systematic risk linked to Covid-19.

Meanwhile Altria doesn't have big risks in those regards. Gradual volume declines? Sure, but that is nothing new. Bit too much debt? Yeah probably. Risks around Juul? Yes but I think you actually missed the biggest. Overpaying is in the past so not worth worrying about now. But if they had to sell Juul and then it became hugely successful after that sale then that could be bad. But I guess if they are forced to unwind their partial acquisition then there wouldn't be anything stopping them acquire part or all of it immediately after. That's the stupid thing with the threat to unwind and why a fine would be more logical. But my point is that these known hugely publicised risks aren't actually that bad vs the huge risks the market is currently ignoring in almost every other company.

Finally I think it could be a great hedge against inflation which could be very valuable going forwards. I don't think there are many sensible options for hedging inflation these days... Which is a problem as the whole world is furiously printing money.

Hence I appreciate your viewpoint and article but I disagree with conclusion. In my opinion, in these uncertain times and at these prices MO is a good choice to round out a balanced portfolio.
Value Kicker profile picture
@LongTermAmateur Thanks a detailed and measured rebuttal. Goodluck!
I remember when more doctors recommended Camels than any other cigarette, but MO has still outperformed RJR since then.
stan11 profile picture
Well written article with good analysis and conclusions, yet folks have been saying that smoking is on the decline since tobacco companies had to start labeling the product as carcinogenic. Yet they're still around, prices rise and fall, and dividends continue to be paid. At least you (the author) agrees it is a bad idea to short MO!!
Buyandhold 2012 profile picture
"it's such a good, good, good, good valuation
It's such a sweet sensation."

And, as we all know, more MO means more money.

Nothing can keep a great investment like Altria down.

Not lawsuits.

Not advertising restrictions.

Not problems with JUUL.

Not restrictions on where you can smoke.

Not high taxes on cigarettes.

Not anti-smoking advertisements.

Because when you want to smoke, you want to smoke.

And Altria has always been a smoking hot investment.

I should know.

I've been an Altria shareholder for 50 years.

They would have to pry my Altria stock certificates from my cold, dead fingers to get me to ever sell even one share of Altria.
Hey there Marky Mark, what were the total returns of the past 10 years?
How does the last decade or the previous one, compares to just having invested in an index fund?
Speaking as member of the generation Y population, I have no intention of holding this bag over the next 50 years.
Buyandhold 2012 profile picture

Are you aware that a $10,000 investment in Altria in May of 1985 with dividend reinvestment would now be worth $2,536,340?
Ta0 profile picture
@Buyandhold 2012
Sorry...you just don't look old enough to have held a stock for 50 years.
Rambrian profile picture
"...the coronavirus pandemic will make a huge impact and leave a lasting impression on young people's lives". I don't see that coming to fruition. Young people simply did not get sick from the virus, meaning not only were they not affected personally but neither were any of their friends. Because of that they will have no instinctive fear of smoking or vaping. Similarly with adults under 50, while they have been deeply affected by the government shutdown very few of them personally experienced the virus to a level that made them seriously ill. I do believe that smoking and vaping will continue to be a big part of American society for generations to come.
Well said. The most under-reported data about COVID-19 is that the mortality rate is essentially zero for anyone under 40.
I read that nicotine can help prevent Covid-19. The valuatiiion, PE and the massive dividend and the cheap price. MO is a dividend aristocrat. Plus the company has said the dividend is very safe. I’m buying.
arthur_bishop1972 profile picture
I'm thinking MO will have a a better than usual q2, and that divi is fantastic. They look like a snail (wrt any real growth) tho atm, so I'm still swing trading it in at least one IRA, and may do the same in the other.
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