Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes, wine, and other tobacco products in the United States and internationally. The current state of the company was finalized after a 2007 and 2008 spin-off of Kraft Foods (KFT) and Philip Morris International (PM). Because these divisions accounted for over two-thirds of the company’s profit before the spin offs, the dividend payment had to be prorated for the legacy US tobacco business. As a result it appeared to be lower than before, while in reality an investor in Altria in early 2007 would have not only maintained but also increased their dividend income. If the dividend record of the old Altria was continued to these days, an investor would find out that the company has raised distributions for 43 consecutive years. This tobacco stock was the best performer in the S&P 500 for the 50-year period from 1957 to 2007.
Currently the company is trading at a low P/E of 13.60, yields 6.70% and has a dividend payout ratio of approximately 80%. The current annual dividend is $1.52/share, and has been raised twice this year. The company earned $1.54/share in 2009 and is expected to earn $1.90/share in 2010 and $2/share in 2011. Altria has a target dividend payout ratio of 80% of earnings per share. This means that the company can afford to pay a dividend of $1.60 by next year, and increase of about 5%. Since 2005, earnings per share from continuing operations attributable to Altria Group have increased by 6% annually.
The economics of the tobacco business are really interesting. Most of the revenue generated from sales go to Federal and State governments, while the cost of the actual product is very small relative to its sales price. The demand is inelastic. When prices for products increase, the increase more than offsets the decrease in consumption caused by the price. This leads to increase in revenues for the cigarette manufacturer.
Supposedly even Warren Buffett liked the economics of the tobacco business in the 1980’s when he said: "I'll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty.” However the increased regulatory actions against tobacco companies have prevented him from investing in the industry since “investments in tobacco are fraught with questions that relate to societal attitudes and those of the present administration...I would not like to have a significant percentage of my net worth invested in tobacco businesses."
The company is a dominant player in the US tobacco market, with a 50% market share in 2009. This mature market is in decline however, and as a result future growth in earnings per share could be difficult to materialize. They would likely come from efficiencies related to restructuring, such as the closure of its Cabarrus facility as well as the integration of smokeless tobacco company UST, which Altria acquired in 2008. Altria expects the UST acquisition to be accretive in 2010. Altria also expects to generate an estimated $300 million in UST integration cost savings by the end of 2011. Altria also expects to achieve approximately $290 million in additional cost savings by the end of 2011 for total anticipated cost reductions of $1.5 billion versus 2006. (Source)
The issues that prevent some investors from purchasing Altria stock are potential liabilities related to possible unfavorable judgments against the company. There were 129 cases pending against the company at the end of 2009 for example. Back in the late 1990’s for example the company’s stock price was hammered on fears that lawsuits could potentially wipeout Altria. In reality it is doubtful that the company would go under, since its tax revenues are needed to fill the empty state and local coffers.
Altria Group, Inc. also held a 27.3% economic and voting interest in SABMiller plc at December 31, 2009. The stake in the company was worth $12.70 billion at year end, which was higher than the 5 billion the investment is recorded on Altria’s books.
I view Altria as a hold if held on its own. If investors also own a share of Phillip Morris International (PM) for every share of Altria (MO) that they own, I would only then view Altria as a buy. Phillip Morris International (PM) owns the international operations of Altria and was spun off in 2008 as an independent company.
Full Disclosure: Long KFT, MO and PM
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