Altria Group Inc (MO)

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High-Yielding Altria Offers the Prospect of Large Returns
By: Guru Focus | August 16, 2020

Shares of Altria Group Inc. (NYSE:MO) have decreased nearly 15% year to date while the S&P 500 has climbed more than 4%. The stock trades with a single-digit price-earnings ratio, well off of its long-term average. Shares also pay an 8% dividend yield. Is now the right time to buy Altria?

Quarterly highlights

Altria reported second-quarter earnings results on July 28. Net revenues were down 3.8% to $6.4 billion. Revenues net of excise taxes declined 2.5% to $5.1 billion. This was $23 million lower than Wall Street had expected. Adjusted earnings per share declined 1 cent, or 1%, to $1.09, but was 3 cents higher than the estimate.

Smokable Products revenue decreased 4.3% to $5.6 billion. Excluding excise taxes, revenue was down 2.8% to $4.3 billion. Domestic cigarette shipment volumes were down 8.8%. When adjusted for trade inventory movements, volumes were down an estimated 2%. For comparison, the domestic cigarette industry volumes were flat, meaning that Altria still lagged the sector as a whole in this area. The company also benefited from a first-quarter stock up on products heading into lockdowns that took place in many parts of the country. March volumes were especially strong, so some volume decline was expected.

Still, this is a better decline than the company has seen in recent years. Helping matters was more of an opportunity for smoking with the consumer at home due to work from home and social distancing directives in the second quarter. A 6% increase in pricing helped offset volume declines.

Altria's flagship Marlboro brand, which represents more than 87% of the company's quarterly smokable products shipments, had an 8.4% drop in volumes. Marlboro retail share declined 60 basis points to 42.8%. Volumes for the other premium brands fell 13.6%, while discount brands were down 9.9%. Total cigarette retail share declined 1% to 49%. Cigar shipment volumes were down 1.4%.

Oral Tobacco Products revenue increased 9.6% to $660 million. Excluding excise taxes, revenue was up 9.8%. Volumes grew 2.8% on higher industry growth. Adjusted volumes were higher by 0.5%. Oral nicotine pouches were a headwind during the quarter as retail share declined slightly but remained high at 50%. Copenhagen, which accounts for 65% of volumes, had a 4.7% increase in shipments, while Skoal declined 7.9%. Copenhagen expanded to 20,000 stores across 36 states during the quarter, but the retail share was lower by 2% to 32.1%. Retail share for Skoal declined 1.3% to 14.1%.

Altria has a license and distribution agreement with Philip Morris International Inc. (NYSE:PM) with regards to its IQOS and HeatSticks products. The Food and Drug Administration gave approval to market these products as Modified Risk Tobacco Products with a "reduced exposure" claim in July. HeatSticks are already sold in the company's IQOS boutiques in several cities in the south, including Atlanta and Richmond, Virginia. Altria expects to have these products in more than 700 retail stores by the end of August.

The toabacco company's other investments didn't perform as well. Its equity investment in Anheuser-Busch InBev (NYSE:BUD) was a headwind during the quarter due to lower reported earnings. Altria has a 10.2% stake in the company. Charges related to Altria's investment in Canadian cannabis company Cronos Group (CRON) lowered earnings per share results by 5 cents. The Juul investment reduced earnings by 3 cents per share. Altria took a $4.5 billion write down on its investment in Juul last October and followed that up with an additional $4.1 billion write down in January. Altria acquired a 35% stake in Juul in 2018 for $12.8 billion.

The company ended first half of the year with $7 billion in current assets on its balance sheet, with $4.8 billion in cash and cash equivalents. Altria drew down $3 billion from its credit facility last quarter. The company has total debt of $29 billion, but just $1 billion of this is due within a year. Share repurchases were suspended last quarter to preserve capital, and this remained in effect for the most recent quarter.

Altria did restore its guidance for 2020. The company guides toward earnings of $4.21 to $4.38 per share for the year. The midpoint of this guidance, $4.30, is just below consensus estimates of $4.32 according to Yahoo Finance. The midpoint would be a 2.1% improvement over earnings from the previous year.

Dividend and valuation analysis

Altria has one of the longest dividend growth streaks in the market. Following a 2.4% increase for the upcoming Oct. 9 payment, the company has now raised its dividend for 51 consecutive years.

The company has an average dividend increase of:

12.5% per year for the past three years.
10.8% per year for the past five years.
9.7% per year for the past 10 years.

Obviously, the most recent increase is considerably lower than any of the listed averages. Lower increases are likely to continue for some time as the earnings per share and free cash flow payout ratios are quite high.

The new annualized dividend of $3.44 would represent a payout ratio of 80% off of the midpoint of projected earnings for the year. This is still higher than the 10-year average payout ratio of 73%. While the free cash flow payout ratio was almost 90% for the most recent quarter, this ratio drops to 61% over the last 12 months.

Shares of Altria yield 8.1% using Friday's closing price of $42.54. For context, the stock's average dividend yield since 2010 is 5.1%.

Altria has long been a high-yielding stock. The stock has traded with a sub-4% dividend yield just twice (2016 and 2017) over the last 16 years, but the current yield is high even for Altria. Shares also have a yield that is 4.5 times the average yield of the S&P 500.

Using the current share price and the midpoint of expected earnings per share of $4.30, Altria's stock has a forward price-earnings ratio of 9.9. Value Line gives a 10-year average earnings multiple of 16.7.

There is an argument to be made that declining volumes for smokable products, which contributes the bulk of revenues, should result in a lower valuation. In addition, the company's other investments, like Juul, have been overhang. Therefore, I believe a price-earnings ratio of 11 to 13 appropriately prices in the negative for Altria. Applying EPS estimates for 2020 to these multiples gives a price target range of $47 to $56. If achieved, shareholders could be in line to see a share price returns of 10.5% to 32%.

The dividend yield would be 7.3% and 6.1% at low and high end, receptively, of my price target range. At a minimum, I feel investors could see a total return of almost 18% if the multiple were to expand.

Final thoughts

Altria had a decent second quarter. Consumers stocked up on products during the first quarter and the company still managed a small decline in volumes when accounting for trade inventory movement. Retail share did decline in its two main business segments. While the news related to IQOS and HeatSticks were a positive, Altria's other investments reduced earnings per share for the quarter.

The stock still looks attractive given these business issues as shares trade with a price-earnings ratio of less than 10. Even a modest reversion to the mean valuation would result in excellent share price returns. Factoring in a high dividend yield that looks safe, and this could be an excellent time to purchase shares of Altria.

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