Altria Is a Dividend-Paying Machine

In this article, let’s take a look at Altria Group Inc. (MO), a $ 82.79 billion market cap company, which is the largest U.S. cigarette producer with roughly 50% share.

Primary Driver

Cigarettes are the primary driver of Altria’s earnings. Marlboro is the dominant cigarette brand in the U.S. The major reason is the quality that Marlboro´s cigarette offers to smokers. However, the cigarette consumption will decline by 3%-4% per year for the next several years. This decline will be the result of health concerns and strict marketing restrictions. The company’s pricing power should offset the decline.

In the next ten years it is probable that Altria will be selling fewer cigarettes because of health concerns and strict marketing restrictions, we believe its smokeless tobacco business is likely to increase volume during the next decade.

Dominant Player

Altria is the dominant player in the U.S. market (with more than 50% share), it can generate the greatest economies of scale in the industry. Marlboro has an exceptionally loyal following, with 90% of Marlboro smokers purchasing the brand 100% of the time.

Combined Power

Philip Morris (PM) and Altria Group Inc. have reached agreements to sell electronic cigarettes and other smokeless products. Philip Morris has exclusive rights to sell Altria’s e-cigarettes (battery-powered devices that heats a liquid nicotine solution in a disposable cartridge and create a vapor that is inhaled) outside the U.S. On the other hand, Altria gains exclusive rights in the U.S. to other tobacco products developed by Philip Morris.

Further, both companies will work together to improve existing products. Altria and Philip Morris International produce and distribute Marlboro, the world’s leading cigarette brand, with an admirable pricing power due to smoker’s fidelity. Altria sells Marlboro in the U.S. and Philip Morris sells Marlboro outside the U.S.

The Threats

The most significant risks for the tobacco industry are regulation and taxation. Despite these risks, tobacco companies are still lucrative, and Altria is poised to generate steady medium-term earnings growth. The addictive nature of cigarettes and Altria’s dominance of the U.S. market are the reasons behind this. Other threat could be the electronic cigarettes, which may help smokers quit. An important characteristic is that e-cig margins are less than common cigarettes margins.

Attractive Dividend Policy

Since 1928, Altria has an attractive dividend policy showing its commitment to return cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. The current dividend yield is 4.6%, which is very good to protect the purchasing power, especially considering the consistency of track-record dividends payments and favorable expectations regarding dividend growth and share repurchases. Management announced a new $ 1 billion share-repurchase program, to be completed by the end of 2015.

Revenues, Margins and Profitability

Looking at profitability, revenue growth by 1% has underperformed when compared to the industry average. Earnings per share increased in the most recent quarter compared to the same quarter a year ago ($ 0.64 vs $ 0.63). During the past fiscal year, the firm increased its bottom line by earning $ 2.26 vs $ 2.06 in the prior year. This year, Wall Street expects an improvement in earnings ($ 2.57 vs $ 2.26).

Finally, let´s compare the best measure of performance for a firm’s management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

The company has a current ROE of 110.1% which is higher than the one exhibit by its peers Reynolds American Inc. (RAI) and British American Tobacco PLC (BTI). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 19.2x, trading at a discount compared to an average of 19.3x for the industry. To use another metric, its price-to-book ratio of 18.89x indicates a premium versus the industry average of 10.42x while the price-to-sales ratio of 4.68x is above the industry average of 3.6x.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $ 10.000 five years ago, today you could have $ 32.440, which represents a 26.5% compound annual growth rate (CAGR).

Final Comment

As outlined in the article, the addictive nature of tobacco products, smokers’ brand loyalty, and significant scale benefits make Altria an interesting option to consider for investor´s portfolios. Further, the stock’s price rise over the last year and the return on equity that significantly exceeds the industry average make me feel bullish on this stock.

Hedge fund gurus like Paul Tudor Jones (Trades, Portfolio), Jim Simons (Trades, Portfolio),Ray Dalio (Trades, Portfolio), Steven Cohen (Trades, Portfolio), Sarah Ketterer (Trades,Portfolio), Murray Stahl (Trades, Portfolio) and Tom Russo (Trades, Portfolio) added this stock to their portfolios in the first quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned