Analysis of Altria Group (NYSE: MO) - Nevin’s Thoughts on Investing
Hi!
Sorry for the late arrival of this issue. There hasn’t been time for me to read or write in the past two weeks. I do most of my reading and writing on the weekends, and the past two weekends have been busy ones for me.
This is the first time I’ve done what might be considered a “deep dive” into a specific company. Altria is my favorite stock at the moment and it’s the largest equity position in my portfolio.
Reply to this email with any questions, comments, concerns, or if you just want to chat. Anything and everything is welcome.
If you love my work, forward this email to a friend or share on social media. And if you don’t already, please follow me on Twitter.
On to the good part…
Business Summary
Altria Group, Inc. is a holding company with several wholly owned subsidiaries plus minority stakes in a few other firms. The company operates in four segments: smokeable tobacco products, oral tobacco products, wine and “All Other” (which consists of innovative tobacco products and financial services). Altria has minority stakes in JUUL Labs, Inc., Anheuser-Busch InBev, and Cronos Group.
The largest segment is smokeable tobacco products. Phillip Morris USA is the largest cigarette company in the United States. PM USA has a market share of 49% of all cigarettes sold in the United States. Their most popular brand is Marlboro which accounts for most of that market share. Middleton is another wholly owned company in the smokeable products segment. Middleton manufactures the popular Black & Mild brand of cigars.
After smokeable products, oral tobacco products is the next largest segment for Altria. US Smokeless Tobacco Company, owned by Altria, is the largest producer of moist smokeless tobacco products in the United States. The primary brands of moist smokeless tobacco products sold by USSTC are Skoal and Copenhagen. USSTC had a retail share of 49% in 2020. Copenhagen has a retail share of 32% on its own. Altria also owns a controlling stake in Helix Innovations LLC. Helix manufactures and markets on! oral nicotine pouches.
The wine segment consists of Ste. Michelle, a producer and supplier of wines. The wine segment accounted for less than 3% of revenue and is, in my opinion, a distraction from the tobacco business for Altria. I won’t mention wines again.
The “All Other” segment consists of innovative tobacco products and financial services. The only item of interest in this segment is the rollout of the IQOS 3, which is a heated, not burned, tobacco delivery method. Sales are very limited in the United States at this time, but it is a potential area of growth in the future. PM USA has the exclusive license to sell the product in the United States.
The company also has several equity investments. Altria owns about 10% of AB InBev, the largest beer company in the world. The company has a 35% stake in JUUL, the largest e-vapor company in the United States. It also has a 43.5% interest in Cronos. Cronos is a marijuana and hemp products company that is mostly active in Canada.
Financial Information
Altria is highly profitable and generates plenty of free cash flow. For the past ten years, the company has averaged 24.6% return on invested capital and 102% return on equity. In every year except 2019 (when Altria took a large charge to write off much of the value of the JUUL investment), the company has had greater than 20% Net Income margin. Selling tobacco is a great business.
Unit volumes have been declining for the past few years as people smoke fewer and fewer cigarettes. Revenue has been stable and increasing slightly because Altria has been able to raise prices on their products. I think it is reasonable to expect that Altria will be able to increase prices to keep up with inflation at least.
With all of the cash generated and few avenues for investment in new products, Altria has been returning massive amounts of capital to shareholders. The company has committed to paying out 80% of it’s net income in the form of dividends. They also just approved a $2.0 billion share repurchase program. Right now the dividend yield is 7.7%.
Altria currently has about $29.5 billion in long-term debt on the balance sheet. This increased dramatically in 2018 when the company invested in JUUL. Historically, it has been closer to $12 billion. The bonds are all fixed rate and the weighted average interest rate is 4.1%. This isn’t a high-yield name. The $6-10 billion in free cash flow per year is more than enough to cover the debt payments and the huge dividend.
Valuation
This is not a well-loved company. People are not beating down the door to invest in the tobacco business. It is cheap right now relative to Altria’s recent history and relative to the overall market. The company currently trades at 9.9x Price-to-Earnings and 8.9x Enterprise Value-to-EBITDA. In the past ten years, Altria on average trades at 15x P/E and 11.5 EV/EBITDA. Obviously the dividend payout ratio of 7.7% is very high indicating that the valuation of the stock is very low.
Bear Case
The company sells products that are actively harmful to the human body and are addictive. Because of this, Altria is subject to regulation at all levels of government and litigation from consumers and groups that can claim harm. Tobacco companies are not allowed to advertise their products at all. They have to put warning labels about the dangers of smoking or ingesting tobacco products on their packaging. Litigation can results in huge settlements against Altria.
To date, these have not been enough to derail the company. The concern is that a settlement is so large that it impairs Altria to the extent that it is not able to continue operating or that its profitability is severely decreased and the stock price falls and can’t recover. Legislatures also have the ability to regulate the sale and use of tobacco in their jurisdictions. I don’t think it’s likely, but states or the federal government could ban cigarettes or ban sales in convenience stores. There are all sorts of limits that legislation could put on the tobacco business in addition to the ones that have already been imposed.
There is an active anti-trust case against Altria and JUUL regarding the JUUL investment made in 2018. JUUL has had to stop selling all flavored e-vapor pods other than tobacco-flavor. JUUL is also subject to other lawsuits related to marketing its products toward minors and the harm that some e-vapor-related products caused users in 2019.
Individuals are also getting wise to the harm that tobacco use causes. Cigarette volumes have been slowly declining. While Altria has been able to raise prices to continue growing revenue, based on the current trend, volumes will eventually fall so far that sales begin shrinking. So far, growth in smokeless products and innovative tobacco products has not had much of an effect on the top or bottom line growth of the company. It is a risky proposition to invest in a business that is harming its customers and appears to have a shrinking customer base.
Bull Case
The past three years since the JUUL investment have been difficult ones for Altria investors. Since June of 2017, Altria’s stock has fallen from over $60 to its low of $29 at the bottom of the March 2020 pandemic selloff. During that time, Altria has written off most of the value of the JUUL investment and the value of the warrant to buy additional shares of Cronos at $19. These write-offs made the income statement uglier than Altria’s actual business performance. The investment in AB InBev was also punished by the closures of bars, restaurants, and hospitality venues since the start of the pandemic in 2020.
All of that is now off the books.
In the fourth quarter of 2020, Altria actually recognized an increased in the fair value of the JUUL investment of $100 million. It’s not much, but it’s a move in the right direction. AB InBev should benefit from the reopening trade and begin their dividend again once the uncertainty surrounding the pandemic subsides.
Assuming no growth of Altria’s sales or profit (which is conservative), the stock has 50% upside just by returning to its historical multiple. As an investor, you are also paid a 7.7% dividend to wait for that return to a mid-teens multiple.
If JUUL, IQOS 3 or smokeless tobacco products are able to grow the business, the upside can be much higher than that. If marijuana is legalized in the United States, the investment in Cronos will position Altria to be a major player in mass-produced marijuana and hemp products. At that point, Altria can become a growth company and the sky is the limit. I don’t think that is a likely outcome, but the chances are non-zero.
Verdict
I gave it away at the beginning of this letter, but I think Altria is a wonderful investment. If you can stomach investing in the tobacco business, the profits are terrific. And despite the high margins, no new companies are entering the cigarette market. Regulations and the unfashionableness of the tobacco industry keep out new entrants. Altria should be able to make a ton of cash for as long as people continue smoking cigarettes. People have been using tobacco for hundreds if not thousands of years, so I think it’s likely that this behavior persists even though everyone knows it’s bad for you.
The financial results are suffering right now from a poor outcome on their investment in JUUL. I don’t personally think that, given the information available when the deal was made, the JUUL investment was a bad idea. It just had a poor outcome due to litigation and bad publicity in 2019.
While the debt burden is higher than I would like on the company, it does appear to be well-covered by the free cash flow from the operating businesses. I don’t see major risks in Altria servicing its debt.
I think that the price today provides a significant margin of safety to a conservative estimate of operating results over the next few years. I think that the most likely scenario is that I can collect my 7.7% for the next few years while the company continues operating at about the same level as today. If the company continues to maintain its revenue and profits at or around current levels, I expect the price of the stock to increase to 14-16 P/E for 40-60% upside on today’s price.
Depending on operating performance in the future, this stock could be a long term hold. Any return to growth due to improved performance from smokeless tobacco products or marijuana investments could make this a once-in-a-lifetime investment. That’s not what I think is the most likely outcome, but there’s a chance.
I’m a buyer of Altria at today’s price.
Subscribe to get my thoughts on public companies and general investing insights. None of this is investment advice. Do your own research before you invest in any security discussed.
If you don't want these updates anymore, please unsubscribe here.
If you were forwarded this newsletter and you like it, you can subscribe here.
Powered by Revue