The market's opinion on Altria (MO) is not at all a positive one right now. Issues that are brought up by investors include debt levels, the fact that the company seemingly overpaid for two acquisitions, and the fact that smoking rates keep declining. On the other hand, the company was very resilient during the first half of the current year, as the tobacco industry is neither impacted by the pandemic nor by the economic slowdown. Altria also trades at a very inexpensive valuation and offers a quite high and safe dividend that yields almost 9% at the time of writing.
No matter how you want to slice it, Altria is cheap: the company trades with the lowest earnings multiple in its peer group, has the lowest PEG ratio, and shares also look quite cheap on a price-to-cash flow or enterprise value-to-free cash flow basis. Last but not least, Altria offers the highest dividend yield, at almost 9% based on its current share price of $39.
What Bears Are Saying
When you ask those investors that are bearish on Altria for their reasoning, several things could come up, including ill-timed takeovers, debt levels, or the fact that smoking rates continue to decline. Let's take a closer look at these things.
First, it is true that Altria's buying of stakes in JUUL and Cronos was ill-timed in retrospect. Altria bought its stake in JUUL at an implied valuation of $38 billion, whereas JUUL is valued at roughly one-third less now, based on the fact that Altria wrote down its original $12.8 billion investment by $4.1 billion earlier this year. There is no way around it - buying JUUL at the valuation Altria paid wasn't a great move. But then, on the other hand, one should ask the question of whether management could have really foreseen that politicians and regulators would move against vaping companies and their products. When Altria made its purchase, this looked like a great deal: JUUL was the clear market leader with a beloved product, especially among younger consumers, and it looked like vaping was much healthier than smoking, so this gave Altria exposure to the reduced-risk product category. Then, soon after the acquisition, a lung illness outbreak occurred across the US. This was mostly related to the vaping of (often informally sourced) cannabis products (which JUUL and Altria do not sell), but regulators did not move too precisely, and the whole vaping industry was classified as dangerous. Neither could Altria's management have foreseen that the vaping of (oftentimes illegal) cannabis products would cause a range of lung illnesses, nor was it Altria's fault that politicians decided to punish all vaping companies, including those that had nothing to do with the issue, such as JUUL. I thus think that the timing of the JUUL stake purchase was bad in retrospect, but I don't really fault management for that.
In fact, Altria as a company has a history of very successful M&A action, and a very convincing long-term track record when it comes to creating shareholder value:
Over the last 50 years, it has delivered a total return of 2.4 million percent - $1 invested five decades ago would be worth $24,000 right now, if all dividends were reinvested.
This gets us to the next point, which is the fact that smoking rates are declining. That undoubtedly is true, but then again, it has been true for decades - and still, Altria shares have generated value like barely any other stock over the last five decades. Even looking at the last 20 years alone, a time during which smoking was out of favor in most circles, Altria's returns trounced those of the broad market:
Declining smoking rates alone thus do not seem to hurt the company too much, which can be explained by the fact that the company is able to more than offset small volume declines through price increases. If the number of smokers declines by 2% a year, for example, but the price per cigarette is increased by 5% a year, overall revenues will continue to climb. This principle has worked for decades, and although there is no guarantee that it will continue to work, it seems reasonable to assume that things will not suddenly make a 180° turn. Altria could thus, despite the fact that smoking rates continue to trend down, be able to generate growing revenues and net profits, as it did for decades.
Last but not least, let's look at Altria's debt levels, as debt is sometimes brought up by bearish investors. According to the company's 10-Q, its long-term debt stood at $29 billion at the end of Q2, including the current portion of its long-term debt. At the same time, it held a cash position of $4.8 billion, for a net debt total of $24.2 billion. This is equal to 2.3 times the company's cash flow from operations over the last four quarters. That does not look like a high leverage ratio in general, and especially not for a reliable, non-cyclical company like Altria, which has no need for large investments in its operations (unlike, for example, an oil producer). We thus believe that debt levels are not threatening at all and that Altria is financed in a solid way.
What Bulls Are Saying
Altria share price has come down a lot in the recent past, and so has its valuation. At the same time, a declining share price has made its dividend yield rise to a high level of close to 9%. For a company with Altria's dividend track record (51 years of rising dividends in a row), that seems like a quite high and attractive income yield. Altria has just reiterated its guidance for 2020, which forecasts earnings per share in a range of $4.21-4.38, with a midpoint of $4.30. With its annual dividend standing at $3.44 right now, the payout ratio is thus exactly 80%, which is perfectly in line with management's target range. When we want to look at cash flows instead, the payout ratio is 62% based on the trailing twelve months' operating cash flow of $10.4 billion, which equates to a coverage ratio of 1.62. To us, it looks like the dividend is rather secure, despite the fact that the dividend yield looks rather high at first sight - this could thus be an opportune time to enter or expand a position in this Dividend Aristocrat, as the market is disregarding the stock right now in favor of shinier industries.
It should also be noted that Altria's business has shown excellent resilience versus the current crisis, as revenues rose by 7% in H1, one of the best records for the company in recent years. Neither the pandemic nor the economic slowdown that followed is hurting the company so far, which can be explained by the fact that smokers smoke more during economic downturns. This built-in resilience versus recessions is also touted by other analysts, who correctly designate Altria as a recession-proof stock.
Looking at the company's valuation, we see that shares are trading hands for the lowest valuation in many years right now:
At 9 times 2020's earnings and at 8.5 times 2021's earnings, Altria trades at a steep discount compared to how shares were valued historically. If shares would rise to a 12 times earnings multiple, which would still be inexpensive versus the 5-year and 10-year median earnings multiples, they would have to rise by more than 30%. Thus, there seems to be significant upside potential for Altria shares in case the market ever reverts back to a more "normal" way of valuing stocks.
When it comes to timing, entering positions while sentiment is weak can be an opportune choice. Altria's RSI (relative strength index) is just 33 at the time of writing:
Its higher RSI in early September is why Cash Flow Kingdom thought buying shares back then was not great timing, but since shares have dropped by another ~10% now, and since the company's RSI signals that shares may have bottomed, entering a position now could also make sense from a technical perspective.
Overall, Altria remains a solid pick that offers strong and growing income, recession resilience, and upside potential for its shares due to a very low valuation. This is not a risk-less investment, but debt levels are not threatening, declining smoking rates have not stopped the company from thriving in the past, and it is doubtful whether one can really blame management for the ill-timed buying of the JUUL stake.
For those interested in a relatively safe ~9% income yield that should continue to grow through regular dividend increases, Altria definitely seems like it's worthy of a closer look right now. Shares are not only very inexpensive on an absolute basis, but also relative to how they were valued in the past and relative to how Altria's peers are valued.