The stock has been going down in price due to the pessimism of
the market. Most of the current worries are due to the declining volume of
cigarette sales. The outcome has inevitably caused the stock value at the
current price. Investors should ignore the noise surrounding their holdings
and, instead, focus on the fundamentals of the company. I had been purchasing
this stock since the beginning of 2018 and had been adding more additional
purchases that make Altria (Ticker: MO) my 4th largest position in my portfolio. By adding more shares to my portfolio, my cost
basis of Altria is currently at $52 per share. This also means that I am currently losing on this
particular stock pick; however, the generous dividend multiple, steady
earnings, dividend growth, and historically low valuation make it impossible
for me to ignore this opportunity to add more shares into my portfolio. I believe
Altria is a great dividend growth stock to purchase now despite many warning
signs. Altria's current low valuation is too attractive to be ignored. This
pessimism is the perfect time for value investors to initiate the purchase of
this stock at the current price.
Altria is going through Many Challenges That Makes Valuations
Attractive.
Altria stock price has been declining since last year, and its
share price is currently trading near its 52-week low range. The company has
underperformed its peers and the S&P500 index this year. If you look at the
chart below, it shows that since last year, Altria has declined close to 34%,
while the S&P500 index has gained 3.4%.
Source: Guru Focus
|
The company declares revenue declined by 6% year-over-year to $4.39 billion, missing $210 million in expectations. The decline is due to a steep 14.3% year-over-year decline in cigarette volume. Many investors are worried about the fall of cigarette volumes every year. I have provided a picture graph below showing how much Altria (Ticker: MO) cigarette volume is declining by each year since 2000. Furthermore, there is disagreement and fear of new settlement towards tobacco companies like Altria. Moreover, other worries, such as Altria's equity stakes of Cronos (CRON) and JUUL (JUUL), seem to be overpriced.
Diving into Altria's 10-K files from 2015 to 2018, there were signs that management lacks the ability to further improve the company’s earning. We can see that Altria's goodwill and intangibles have remained not too many changes.
With revenue declining and less marketing on branding, Altria's brand is not as strong as it used to be. I have a difficult time believing that management has factored in all the development over the past years in the company's goodwill and intangibles valuation. Even though the tobacco segment only accounts for about one-third of their goodwill and intangibles, this might lead to impairment in the future and a negative non-cash charge on the income statement. Furthermore, the company has lowered its full-year earnings expectation from $4.22 per share to $4.21 per share. The decline expectation is because they expect a full-year total domestic cigarette volume to decline by 4 to 5 percent. From this result, the market is worried about the company's ability to grow, especially the downfall of cigarette volume.
I am also worried about the increase in inventory in the company
while its revenue is declining. In the first quarter of the March earnings
call, Altria mentioned that customers were trying to deplete their inventories,
which can be seen after Altria raise its prices. During the second quarter,
Altria was able to lower their inventories, but this might be due to the
increase in price in early June. I will keep an eye on Altria's inventory
levels.
Source: Balance Sheet |
Regarding their pension account, I found it unusual that Altria made a more significant pension plan payment. In 2016 and 2017, Altria's earnings were higher than average. Higher incomes can be explained in two ways. It's either Altria's management is trying to smooth out their profits by making higher payments when earnings are high and the contribution when profits are lower (earning manipulation). The other reason that can be caused by Altria's management is to take care of their plan participants. They use the one-time profits to increase the plan assets coverage so that any shortfall would not occur (conservative management).
The last worrying signal that caught my attention is looking at Altria's low current ratio (compared to historical level). Most of this has to do with the JUUL investment, and it's something that we might want to see going forward.
Long-term debt has increased from $12 billion to $27 billion, which resulted in Altria to have a debt/equity ratio of 2.
Source: Morning Star |
Despite these red flags, Altria’s ability to be able to improve their gross and operating profit margin is impressive. They were able to maintain a remarkably high-profit margin years after years.
Source: Balance Sheet |
The cost of sales and excise taxes fall faster than the decrease
in revenue. The decline in revenue has been a significant reason why Altria was
able to maintain its earnings growth. During the second-quarter earnings call,
Willard mentioned that he has confidence in Altria. He believed that Altria
would continue to generate excellent profit growth out of its combustible
volatile segment. He knows that Altria has experience in driving profitable
growth in the company through pricing and cost management. Also, Altria has the
opportunity to continue driving similar profit growth by utilizing the
experience slightly different from its peers.
At the current $40 price
range, Altria Group
(Ticker: MO) stock is a great value stock for a dividend growth
investor. The company's P/E was as low as 9.3 in
the year 2009 and as high as 24 in
the year 2017. The average P/E ratio of this company has been in 15.8. In
most years, Altria is a hated stock because of the products they sell. Taking into
account that Altria is a sinner stock, I would say the fair value of this stock
is between 12 and 14 times earnings-to-price. If by next year Altria is traded
between 12 to 14 times
earnings-to-price, Altria would have a share price of $55 to $58. The
increase in share price implies a 30 to 40% upside,
which includes dividend payout.
Altria forward price-to-earnings ratio as of September 2019 is
at 9.10, and it's below the ten years average
price-to-earnings ratio of 15.8. Comparing its price-to-earnings ratio to the
S&P500 overall market P/E makes Altria stock look attractive in value
investment point of view. This ratio is considered to be a modest P/E ratio
since Warren E. Buffett himself likes to invest in companies that have a P/E
ratio of 15 or below. I think Altria's current P/E ratio
seems fair for an investor to enter.
The Discounted Cash Flow Analysis.
From a pure dividend growth perspective, you can value Altria by
merely adding the current yield with the expected growth of earnings. This forecast
would result in a 12% - 17% annual return without an increase in the price
of the stocks relative to its earnings.
Valuing Altria with a multi-period discounted cash flow model
requires more inputs. I used 10% as the rate of return, which is slightly
higher than the average performance of the S&P 500. I want to take into
account the risk involved in investing in an unloved stock such as Altria. The
company's most pessimistic forecast is to increase its earnings per share by (4% this
year and 7% for the next four years after this year).
Also, management mentioned their most optimistic earnings forecast of attaining
(7% growth
this year and 9% after that) over a time horizon of 5 years.
Another assumption I made in this model is the growth rate of the
stock price and dividends. It will be equivalent to the growth rate of
earnings. The premise is consistent with Altria's commitment to maintaining an 80% dividend
payout ratio. Also, I also include the extra pessimism or optimism in Altria's
fair value by adding an extra margin (-20%) of
a margin of safety on the downside and extra optimism of (+20%) on
the upside. This additional margin will let us see Altria's possible outcomes.
These assumptions made me present the stock value between the
price of $48 and $86 with
P/E of 10 in 5 years
ahead (adverse scenario) or P/E of 19 in
the most optimistic scenario. Without any adjustment, I would believe Altria's
fair value price is between $55 price range to $65 price
range. The fair value is assuming that its management keeps up with its
promises.
My Valuation Outcome.
The simplest model I have used points towards a fair value of $55-$65.
This fair value is further backed by historical valuation and in line with the
reasonable value estimate of $58 that Morningstar provided. P/E ratio under 12 makes
me comfortable in investing in Altria. Also, its Enterprise Value to EBITDA
ratio looks excellent at 9.92. EV/EBITDA ratio of below 10 is
healthy and considered above average by an analyst, and Altria has this ratio
below that number. The low ratio is another good reason why I think Altria is
trading at an attractive valuation.
Moreover, Altria has an attractive earning-yield-to-price of 9.86%,
which shows how profitable the company is. It shows that Altria is a company
that generates good income. Price-to-Free-Cash-Flow of 11.47 shows
signs of attractiveness as an investment. The ratio indicates that the company
provides excellent free cash flow, which is considered essential by value
investors. Having Price-to-Free-Cash-Flow of 11.47 means
that Altria can cover back its free cash flow to investors within 12 years
period of time. The result can happen if Altria was able to sustain the same
free cash flow. Investing in companies that provide positive free cash flow can
grow the business, reduce debt or return to shareholders as in dividends or
share repurchase.
Furthermore, the company premium brand such as Marlboro has
enabled the company to produce a strong return on invested capital. Altria
generated a high 21% return on invested capital in the fiscal year
2018. The high ROIC ratio shows that Altria can generate a higher return on
investment than its costs of capital expenditures. Moreover, this ratio proves
that the company is creating value for the company and its shareholders. There
is enough margin of safety for investors to invest in this company in the long
run based on its history.
Altria Has a Great Economic Moat.
I think Altria is an excellent company that has a strong
economic moat. New industries that want to enter the cigarettes business will
have a difficult time competing with a developed business like Altria. Even
when Altria is facing trouble with the decline of smoking rates, the company
continues to find ways to drive its profit up by making acquisitions in growing
companies.
Cronos Group
The company recently has entered and invested $1.8 billion in
a Canadian Cannabis Company called Cronos Group that produces marijuana. They
purchased a 45% equity stake of the company and have a warrant
to acquire an additional 10% ownership interest in Cronos Group for $19 Canadian
Dollar per share. This warrant can be exercised for over four years. This
investment is a good sign of growth. Many states in the United States have
already legalized marijuana for consumers. The number of cannabis consumers is
increasing rapidly. According
to a study by 2018 State of Cannabis Report shows that consumers placed a
cannabis order every 8 seconds in the year of 2018. First-time cannabis consumers grew by 140%. The
average cannabis consumer age is 31; Baby Boomers result in 25% growth
in the industry. They are one of the most significant cannabis spenders. On
average, they spend 53% more than Generation Z consumers. In addition,
females have also increased in the cannabis market. The number of female users
doubled from 2017 to 2018, and
they made up 38% of the cannabis consumer.
I view this equity stake as an investment in research &
development. Due to the federal restrictions, this was the most natural path to
start setting up their distribution channel and built their supply chain to
make an expeditious entry in this market niche once legalized on the federal
level. Having Altria Group, Inc. entered the marijuana industry can be a
turnaround for this company. Furthermore, there are not many companies that can
scale up and satisfy consumers faster than Altria. Altria can quickly increase
their earnings towards the future and provide a higher dividend payout for the
investors.
JUUL Labs
Separately, Altria has announced to invest $12.8 billion in
e-vapor manufacturer called JUUL Labs at 28x 2018 sales
or 12x expected 2019 revenue.
Altria invests approximately 35% equity stake in JUUL Labs. I think Altria had
overpaid for the acquisition equity stake of JUUL Labs. Despite having Altria
paying a premium for the company, I do believe this is a sign of the strength
of joining with a growing company.
They were able to report 175% growth
in liquid pod shipments in the first quarter of 2019,
which increase their market share to 43%.
Altria was able to grow this division business to nine countries, such as
Canada, France, Germany, Italy, and Switzerland. If this robust domestic and
international growth continues, the vaping business sector can contribute a
significant amount towards the company's growth rate in 5 to 10 years.
This acquisition shows that Altria is finding a solution to declining cigarette
sales volume by acquiring a stake of companies that sells alternative products
to cigarettes. Having to acquire JUUL as an investment, Altria will likely to
discontinue its own e-cigarette brand MarkTen. By having MarkTen stopped can
provide a cost-cutting program that can reduce annual expenses by $500 to $600 million.
U.S. Smokeless Tobacco Company
U.S. Smokeless Tobacco Company is the producer of Copenhagen,
Skoal, Red Seal and Husky brands of smokeless tobacco. The company is
considered to be the world's largest chewing tobacco marketer. They control
more than half of the U.S. smokeless tobacco market. Altria's chewing tobacco
division has shown reliable results. Over the past two years, revenue from
chewing tobacco division has increased by 5%, which
results in 8% income growth over the past year in this
sector. Altria can capture 35% of this niche market, making them the dominant
player in this industry. From the data shows that despite the sales volume of
cigarettes are declining, Altria managed to find a solution to keep its earning
high.
Because of Altria's great business network relationship,
regulatory know-how, and economies of scale gives Altria a competitive
advantage. Altria's competitive advantage is so difficult for other companies
to replicate or enter into this business niche. Also, the company would still
survive if there is market turmoil. We know that consumers would again purchase
these addictive products. Cigarette and Alcohol sales tend to do well during a
recession, which can sustain the company's profitability and dividend growth.
Furthermore, in the United States, cigarettes remain affordable
to consumers since the price-to-hourly wage is high. Therefore, because their
products are addictive, they have a chance of continuing to increase the price
for their product years to come without risk of losing their consumers. Also,
as production and agricultural efficiencies continue to improve due to
technological advancement, Altria's expenses and cost would decline, which will
increase the company's earnings.
Altria is a Great Starting Dividend Yield Company for Investor.
At the current price, Altria has a forward dividend yield of 8.37%.
That's $3.36 forward dividend payout per share of every
Altria's share you own. 8.37% is a good starting dividend yield for an
investor who wants to start a dividend growth stock position. However, the
company has a relatively high dividend payout ratio of 80%. This
ratio shows that most of the earnings you receive from the dividend are paid
out from its earning. Altria's dividend payout ratio has always been high. If
you check on the graph, I have provided below; you can see that Altria's last
five years' dividend payout ratio. I believe that Altria can sustain a payout
ratio below 1.00.
Also, what makes this dividend stock attractive is looking at
the company's tracking record. We can see the dividends have increased every
year. Looking back five years ago, Altria has an annual dividend growth rate of 9.7%. This
dividend growth rate shows that management work consciously to keep up with
maintaining its earnings growth and dividend payout. Moreover, this also
indicates that Altria forward dividend yield is sustainable towards the long
term. It shows that if you had purchased the stock five years ago, you would
receive a dividend yield-to-cost of 10.28%.
That's pretty impressive! The company generates $1 billion annually
in excess cash that can be used to pay down debt, grow its dividend, or buy
back shares.
Moreover, the company has also been purchasing its share back,
which shows a great sign. When a company buys back shares that are outstanding
in the market gives the owner a higher percentage of ownership in the company.
I like the dividend that Altria is paying out. There is a high probability the
dividends would increase since Altria has the reputation of increasing its
dividend. It maintains a dividend payout ratio of below 1.00.
Final Thoughts.
Altria has delivered outstanding results over the past 50 years.
I have a high conviction that they will still be in business decades ahead. The
current price will turn out to be a bargain if management can deliver what they
promise.
I expect that the company could grow its earnings by 7% to 9% per
year over the next five years. The reason is that I believe in the strong
performance in chewing tobacco, vaping, and cannabis business. Having these
businesses can help Altria to keep growing its revenues, earnings, and
dividends years to come. Also, I expect that the company would gradually
increase its margin expansion in the shrinking cigarettes business.
I expect Altria to have total returns of above 10% per
year over the next five years. This potential return is a lovely figure knowing
that this is a recession-resistant stock. With this information I have
provided, I feel this 8.37% dividend yield stock is an excellent buy at
the current $40 price range. This dividend growth stock is
outstanding for conservative income investors who want a high sustainable
dividend yield it provides. I have added a position in Altria stock at $41.65 price
range and would add more if the share price goes down further.
I like MO a lot under $50. It has rebounded a little from its recent lows a few weeks ago. Like you think... I agree it still looks attractive at current levels and that yield is hard to ignore.
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