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Thursday, October 10, 2019

Altria: A Great Value Dividend Stock to Buy Now

Altria Group, Inc. (Ticker: MO) is a company that has been established for a long time. This company has been paying dividends to its shareholders for a long period of time and is considered to be Dividend Aristocrat Stock. Altria Group, Inc. is a well-known American company that produces and market tobacco, such as cigarettes and related products. The company headquarter is in Henrico County, Virginia, close to the city of Richmond and was founded by Philip Morris in 1847. The company sells the Marlboro brand cigarettes in the United States. They also sell non-smokeable products such as Skoal, Copenhagen, and the Ste. Michelle brand of wine. Moreover, they also have 10% ownership in global beer giant Anheuser Busch InBev. 

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 portfolioI 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.
Source: Tax Burden on Tobacco 1970-2018

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.
Source: Balance Sheet

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).
Source: Cash Flow Statement and Forms 10-K

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.
Source: Balance Sheet

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.
Source: Guru Focus

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.

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.
Source: Guru Focus

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.
Source: Guru Focus

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.


  1. 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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