Via SeekingAlpha.com

Altria (NYSE: MO) is a major tobacco company focused in the United States that offers a potential buying opportunity for investors. During Q1 2020, the company provided strong growth in its core smokeable and oral tobacco products, resulting in significant increases in key financial metrics. Furthermore, Altria currently boasts an appealing P/E ratio valuation, a near-historical high dividend starting yield of about 9% and has dividend payments that are solidly covered by its free cash flow. Although Altria still faces challenges with some of its acquisitions to drive future expansion, the company’s core business is providing strong income growth and maintains a solid retail share in the United States. Based on this analysis, Altria is in a position to continue to deliver strong financial performance to support its impressive current dividend, which could potentially offer a very strong dividend stock for investors.

Smoke, Cigarette, Cancer, Hand, Marlboro

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Financials

Looking at Altria’s Q1 finances over the last ten years, we can see that it has been steadily increasing its key financial metrics. Over the last decade, the company has reliably increased its revenue, gross profit, net income and adjusted EPS (Q1 basis, 3 months ended), recording a 13% increase in revenue and an 18% growth in adjusted EPS since Q1 2019. Furthermore, the gross margin and net income margins have increased by about 25% and 75% respectively since 2010, with this partly due to increases in premium cigarette prices and cost-cutting measures enacted over the last few years. It’s also worth noting that Altria has significantly increased its long-term debt since 2017 due to recent acquisitions (more on this below), though the debt is still at a manageable amount for a company of this size.

(Revenue, Income, Gross Profit & Long-Term Debt in millions) 3 Months Ended March 31 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Revenue $5,760.00 $5,643.00 $5,647.00 $5,528.00 $5,517.00 $5,804.00 $6,066.00 $6,083.00 $6,108.00 $5,628.00 $6,359.00
Gross Profit $2,084.00 $2,148.00 $2,202.00 $2,674.00 $2,256.00 $2,475.00 $2,656.00 $2,776.00 $2,936.00 $2,811.00 $2,873.00
Gross Profit Margin % 36.18% 38.06% 38.99% 48.37% 40.89% 42.64% 43.79% 45.64% 48.07% 49.95% 45.18%
Net Income $813.00 $937.00 $937.00 $1,385.00 $1,175.00 $1,018.00 $1,217.00 $1,401.00 $1,894.00 $1,120.00 $1,550.00
Net Income Margin % 14.11% 16.60% 16.59% 25.05% 21.30% 17.54% 20.06% 23.03% 31.01% 19.90% 24.37%
Long Term Debt $11,185.00 $12,194.00 $13,089.00 $11,894.00 $13,992.00 $12,901.00 $12,846.00 $13,033.00 $13,030.00 $27,042.00 $26,971.00
Adjusted EPS $0.39 $0.45 $0.48 $0.69 $0.59 $0.52 $0.62 $0.72 $1.00 $0.92 $1.09

(Source: Created by author using data from MO 2010 10-Q, 2012 10-Q, 2014 10-Q, 2016 10-Q, 2018 10-Q, 2020 10-Q and MO Q4 Quarterly Results)

Taking a closer look at the P/E ratio, which is a commonly used metric for determining stock valuation, we can see that Altria is at a deep discount valuation. It is estimated to have a forward P/E ratio of approximately 8.83x as of Friday, May 22. Comparing this with the historical adjusted P/E ratio of the company, we see that Altria’s P/E ratio has been higher 99.2% of the opening market days over the last decade and 98.5% of the opening market days over the last five years. The adjusted P/E ratio graph below was calculated by dividing the opening price for all market days during the last decade by the adjusted EPS reported for that particular year. Taken together, Altria had a solid first quarter in 2020 that delivered on key financial metrics and is at a historically appealing adjusted forward P/E valuation.

(Source: Created by author using data from MO Q4 Quarterly Results)

Core Business Overview

In order to understand if Altria’s dividend is sustainable, let’s take a look at the company’s core businesses. As of Q1 2020, its three core business segments included:

1) Smokeable Products – The sale of combustible tobacco products including cigarettes and cigars.

2) Oral Tobacco Products – The sale of orally delivered tobacco (non-combustible) products including SNUS products and oral nicotine pouches.

3) Wine – Sale of wine produced by Ste. Michelle.

It’s also worth noting that Altria has positions in a number of other businesses, including alcoholic beverages, cannabis and e-cigarettes (more on this below). Looking at these three divisions within Altria, we can see how essential the smokeable segment is to the company. Over the last five years, the smokeable products segment has accounted for about 85% of the total income for the company. The oral tobacco products segment has also seen small growth over this time, offsetting the decline of the wine segment. In summary, Altria’s income is very dependent on its smokeable products segment and, to a lesser extent, its oral tobacco products segment.

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(Source: Created by author using data from MO 2015 10-Q and 2020 10-Q)

Smokeable Products Segment

The smokeable products segment sells both cigarettes and cigars, with the primary products being:

  1. Cigarettes – Make up over 98% of Q1 2020 total smokeable products sales. Sales include Marlboro, other premium and discount cigarettes.
  2. Cigars – Make up under 2% of Q1 2020 total smokeable product sales. Sales include Black and Mild and other cigars.

Cigarette sales make up the majority of Altria’s core business, with its Marlboro product making up the largest portion of the company’s total cigarette sales (more on this below). Looking at the other comprehensive income (OCI) from Q1 2020, we can see that Altria’s smokeable products segment delivered very strong results. Over the last five years, the smokeable products segment OCI has been steadily increasing (Q1 basis, 3 months ended), with this last quarter having an over 20% growth compared to last year.

(Source: Created by author using data from MO 2015 10-Q, 2016 10-Q, 2018 10-Q and 2020 10-Q)

One of the challenges that the company faces is the decline in smoking volumes in the United States. As we discussed in my previous article, cigarette sales have been generally decreasing since the mid-1960s in the United States, with Altria’s smokeable product sales decreasing about 5% from Q1 2015 to Q1 2019. What’s interesting here is that the total sales for the smokeable product segment actually increased during Q1 2020, with this last quarter recording a 6% increase in smokeable product shipment volumes compared to Q1 2019.

(Source: Created by author using data from MO 2015 10-Q, 2016 10-Q, 2018 10-Q and 2020 10-Q)

Part of this increase in sales has been attributed to recent “pantry loading” consumer behavior. During this global healthcare crisis, there has been a rise in stockpiling of commodities, including toilet paper, food and other consumer goods. In particular, consumers have also been stocking up on cigarettes, leading to some of the observed increase in sales over the last quarter. However, even taking into account the effect of pantry loading, we can see that the rate of cigarette decline decreased during the first quarter of 2020. Furthermore, this decrease is in line with Altria’s prediction for cigarette volume during the company’s Q4 2019 earnings call, which considered a number of factors, including the increased legal minimum age to smoke. Taken together, Altria’s smokeable product segment had strong performance during Q1 2020, delivering high OCI growth and strong smokeable product sales in line with the company’s long-term predictions.

(Source: Created by author using data from MO 2020 Q1 Presentation)

Another potential challenge to Altria is the loss of the retail share of its cigarette products in the United States, especially with its most profitable and iconic Marlboro brand. Cigarette demand is inelastic, which means that large price increases only induce small decreases in demand. This has allowed the company to increase the price of its smokeable products, especially its iconic Marlboro brand, to drive profits and its impressive margins. Below, we can see that Altria’s total retail share has only decreased slightly over the last decade due to a decline in sales of its other premium brands. However, the company’s key Marlboro brand has maintained a strong retail share during this time period, due in part to reward and other loyalty programs. The ability of Altria to maintain its strong retail share, especially for its key Marlboro brand, will be essential for the company to be able to support its dividend.

(Source: Created by author using data from MO 2010 10-Q and 2020 10-Q)

Oral Tobacco Products Segment

The oral tobacco products segment is part of Altria’s long-term strategy to provide more sustainable products. Some of the oral tobacco products include:

  1. Copenhagen
  2. Skoal
  3. Other products

Altria’s oral tobacco products segment also provided stable results in Q1 2020 that were in line with previous Q1 performance. This segment has, in general, experienced steady growth, with the last five years experiencing about a 12% increase in OCI annually (Q1 basis, 3 months ended). This quarter fell in line with previous results, with OCI increasing by about 13%.

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(Source: Created by author using data from MO 2015 10-Q, 2016 10-Q, 2018 10-Q and 2020 10-Q)

In contrast to the declining smokeable product segment, sales for the oral tobacco products have been relatively stagnant. Over the last five years, there has only been a 0.6% increase in total sales for this segment on average, with Q1 2020 providing about a 2.7% increase in oral tobacco product sales. We can see that the oral tobacco products segment provided stable growth during Q1 2020, with the results being slightly better than the average growth over the last five years.

(Source: Created by author using data from MO 2015 10-Q, 2016 10-Q, 2018 10-Q and 2020 10-Q)

One of the challenges Altria’s oral tobacco product segment faces is the decline of its presence in the market. Since 2010, the company’s retail share for the oral tobacco products decreased by about 5%, with the majority of this loss coming from decreases in sales of its Skoal product. However, Altria still holds an over 50% retail share for its oral tobacco products, which is in line with its smokeable products and still a respectable share of the oral tobacco market. Altria’s ability to maintain and expand its presence in the oral tobacco product space will be important for the future financial performance of the company.

(Source: Created by author using data from MO 2010 10-Q and 2020 10-Q)

Wine Segment

The wine segment had the weakest financial performance out of all of Altria’s core business segments. Over the last five years (Q1 basis, 3 months ended), the wine division OCI has decreased by over 50%. Q1 2020 marked an even larger decrease, with OCI declining by over 13%. The challenges with the wine segment seem to revolve around changing consumer tastes and long-term non-cancelable grape purchases. Given the declining performance and challenges the wine segment faces, Altria and Ste. Michelle have implemented a strategic reset focusing on:

  1. Updating their approach for determining future demand
  2. Supply chain optimization
  3. Reduce/eliminate underperforming brands
  4. Streamline operations to increase margins (currently, the wine segment has about a 9% adjusted OCI margin, which is significantly less than Altria’s other core businesses)

(Source: Created by author using data from MO 2015 10-Q, 2016 10-Q, 2018 10-Q and 2020 10-Q)

Although the ability of this strategic reset will be critical to the future of Altria’s wine segment, the small degree of operating income from the wine segment compared to the rest of the company will likely result in a negligible financial impact for Altria.

Dividend Analysis

Not only has Altria had a strong quarter of sales following the start of this global healthcare crisis, but the starting dividend is also quite high, even compared to historical stock price lows from prior recessions. Below is an analysis of the percent of market days (vertical axis) that had a particular starting dividend (horizontal axis) determined from the opening market price of Altria during the 2001, 2008/09 recessions and 2020 year to date. Here, we can see that the company’s starting dividend in 2020 has been significantly higher than the 2001 recession and still, on average, higher than the 2008/09 recession. Furthermore, we can also see that the current starting dividend is much higher than it was for most of the 2001 and 2008/09 recessions. For the purpose of this analysis, the 2001 recession includes market days between March 1, 2001 and November 20, 2001, and the 2008/09 recession includes market days between April 1, 2008 and June 30, 2009.

(Source: Created by author from MO opening price data)

One of the primary concerns about Altria is the company’s ability to continue to support its dividend. Altria’s low capital expenditures and high profitability allows it to support higher sustainable dividend payouts than many other companies. Looking at the dividend payouts in comparison to the free cash flow for the company over the last decade, we can see that free cash flow typically covers the dividend payments. Since 2018, free cash flow has solidly covered the dividend payments, with Q1 2020 boasting a 51% cash dividend payout ratio (partly due to the observed pantry loading, see above). Interestingly, the dividend increases on a per share basis have been growing faster than the total dividend payments from the company over the last decade, driven by the 10% decrease in outstanding shares from share buybacks during this time period. In summary, Altria boasts a very high starting dividend yield, even compared to prior recessions, and has the free cash flow to support the dividend.

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(Source: Created by author using data from MO 2010 10-Q, 2012 10-Q, 2014 10-Q, 2016 10-Q, 2018 10-Q and 2020 10-Q)

Other Potential Risks

As I discussed in my previous article, Altria has a number of strategies moving forward to drive growth for the company. As of the end of Q1 2020, many of these potential growth drivers have encountered challenges over the last year. Some of these challenges include:

  1. Anheuser-Busch InBev SA/NV (BUD): The company has been impacted by the global health crisis, leading to a 50% reduction of its upcoming dividend and withdrawal of earning guidance.
  2. JUUL (JUUL): JUUL recorded a $1 billion loss in 2019. Altria has also seen a spike in pending legal cases related to its investment in JUUL.
  3. Cronos (OTC:CRON): Cronos is still facing various financial and accounting challenges, with Altria recording a loss of $89 million in Q1 2020. However, this is less than Altria’s recorded loss of $425 million in Q1 2019 (note that these results are accounted with a one quarter lag).
  4. Heat-not-burn IQOS product: Altria has delayed sales of IQOS and closed its Atlanta and Richmond stores due to the global health crisis.

As we can see, many of the potential growth drivers for Altria currently face a number of problems, at least in the short term. Although its core business can insulate the company from these challenges and cover the dividend for the foreseeable future, the historical decline of the cigarette industry will likely require some of these investments to help drive future dividend increases for Altria shareholders.

Final Thoughts

There is a great deal to be optimistic about Altria’s Q1 2020 performance. This company provided strong growth of key financial metrics this last quarter, supported by strong OCI growth for its core smokeable and oral tobacco products segments. Additionally, Altria currently boasts an extremely lucrative valuation, with the current adjusted P/E ratio (about 8.83x) being lower for only about 0.2% of the total market days during the last ten years. Furthermore, even after adjusting for pantry loading and the increase in the minimum smoking age, the cigarette volume decline is still in line with previous long-term predictions. Finally, the starting dividend yield is still very high (about 9%), with the company’s free cash flow solidly paying its dividend. Taken together, Altria provided strong performance in Q1 2020, is at a low valuation and is in a promising position to support its excellent dividend yield.

However, there are challenges that Altria faces going forward. As discussed in my previous article, the company has made a number of acquisitions recently that have resulted in poor financial returns over the last few years. Furthermore, many of these strategic investments that Altria is depending on for future growth are currently facing challenges, including limited operation capacity and various legal litigations. Finally, Altria is very dependent on its smokeable division, especially its Marlboro brand, and changes in consumer preferences away from its premium Marlboro product would be detrimental to the company’s core business.

Below, I summarize what aspects of the company I’m personally optimistic and pessimistic about going forward. Although Altria may face challenges to drive future growth from its strategic investments at least in the short term, the current valuation, stable core business and impressive starting dividend yield more than make up for these downsides, in my opinion. Considering the pros and cons, I am personally excited to continue to add more Altria stock to my portfolio.

(Source: Created by author)

Disclosure: I am/we are long MO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial advisor, please contact a licensed financial advisor and do your own research before investing.