Published December 13th, 2016 by Bob Ciura
Altria Group (MO) may not sound like a familiar name, but it has one of the longest and most impressive dividend growth stories in the entire market.
Altria is the owner of Philip Morris USA, which houses its flagship Marlboro brand.
The company has rewarded shareholders with reliable dividend growth for a very long time. It is a Dividend Achiever, a group of companies that have raised dividends for at least 10 years in a row.
You can see the entire list of all 273 Dividend Achievers here.
But Altria’s dividend history is even more impressive than that. It has raised its dividend 50 times in the past 47 years.
The reason why Altria is not a Dividend Aristocrat is because, through various spin-offs over the years, Altria’s quarterly dividend has technically not been raised long enough to qualify.
Don’t be fooled—Altria is just as strong a dividend stock as any of the Dividend Aristocrats. In fact, the company is one of the core holdings of Mr. Wonderful’s Quality Dividend ETF (OUSA). This article will review Altria’s business model and its outlook.
Altria has a tremendous business model. It manufactures cigarettes, but also a number of smokeless tobacco products. It also has cigar and wine businesses. A breakdown of Altria’s business segments is as follows:
- Smokeable products (89% of revenue)
- Smokeless products (8% of revenue)
- Wine (3% of revenue)
The smokeable products segment includes cigarettes and cigars. Altria operates the Black & Mild cigar brand in addition to the core Marlboro brand.
Altria’s smokeless products segment includes chewing tobacco, under the Copenhagen and Skoal brands.
Lastly, Altria has a small wine business under the Ste. Michelle brand.
Outside of its operating segments, Altria owns an approximately 26% stake in beer giant SABMiller plc (SBMRY).
Source: 2016 CAGNY presentation, page 14
This is a significant equity investment which contributed $8.7 billion in equity earnings, and another $3.8 billion in dividends, to Altria from 2002-2015.
Clearly, the smokeable products segment is Altria’s most important business. The company has diversified itself in recent years by moving into chewing tobacco and wine, but cigarettes are its most important product line by far.
This presents a problem for Altria. Cigarettes built Altria into a dividend powerhouse over the past five decades. But the consumer landscape is shifting. Smoking rates are declining in the U.S., particularly among younger consumers which Altria needs to replace older customers.
Source: Annual Shareholder Meeting, page 24
Altria’s U.S. cigarette volume declined 2% in the first three quarters of 2016. To offset this, the company is turning to new products and price increases to fuel future growth.
Altria is a very strong company. For example, in 2015 Altria generated $5.6 billion of free cash flow. Its tremendous free cash flow fuels Altria’s impressive dividend.
But while Altria has had an extremely impressive past, its future is cloudier.
Because of the decline in smoking rates, the cigarette industry has a challenged outlook. This means that Altria could use a growth catalyst. Fortunately, there are a few ways in which Altria can continue to grow.
One potential catalyst is e-cigarettes.
E-cigarettes appeal to consumers who are shifting away from traditional cigarettes. The e-vapor category has seen impressive growth over the past few years.
Source: 2016 CAGNY presentation, page 55
Altria has invested in e-vapor product development through its NuMark subsidiary, which operates the MarkTen brand.
Altria is aggressively expanding the MarkTen XL e-vapor product to retail channels that comprise more than half of e-vapor volume. It is also developing a heated tobacco product, which heats tobacco rather than burn it, to produce less ash.
Aside from these catalysts, Altria’s plan to grow revenue and earnings-per-share revolves around price increases and cost cuts.
Altria’s main competitive advantage is scale. It enjoys low capital expenditures each year, thanks to its production and distribution capabilities. And, since tobacco companies are banned from advertising in the U.S., Altria has virtually no advertising expense.
This results in Altria’s high free cash flow.
Another competitive advantage for Altria is its brand strength. For example, the Marlboro brand dominates the U.S. cigarette industry.
Source: Annual Shareholder Meeting, page 9
According to Altria, Marlboro controls more market share than the next 10 largest brands combined.
This brand strength is critical to Altria’s growth strategy, because it allows the company to raise prices regularly.
Moreover, according to Forbes, the Marlboro brand is the 26th most valuable brand in the world, worth $21.9 billion.
Price increases helped Altria expand profit margins this year. Smokeable segment operating profit margin expanded by 1.6% over the first nine months of 2016.
Overall, price increases and cost cuts led to 10.3% growth in adjusted earnings-per-share over the first nine months of 2016.
Valuation & Expected Total Return
The one downside to Altria stock is its current valuation. The stock price has risen significantly over the past five years, far ahead of its earnings growth rate.
Altria stock trades for a price-to-earnings ratio of 25. This is slightly below the S&P 500 Index, which trades for a price-to-earnings ratio of 26.
But since 2000, Altria stock has traded for an average price-to-earnings ratio of 16.
Altria stock typically trades at a discount to the S&P 500. But the rush for yield in a low interest rate environment has elevated its valuation.
A possible breakdown of Altria’s future shareholder returns is as follows:
- 2%-4% revenue growth
- 1%-2% price increases
- 1% profit margin expansion
- 1% share repurchases
- 3.7% dividend yield
Going forward, Altria stock could generate approximately 9%-12% total returns each year. The dividend will represent a major piece of total returns. Fortunately, the dividend is rock-solid.
Altria can still produce nearly double-digit adjusted earnings growth through a combination of price increases, cost cuts, and share repurchases. As a result, the dividend is covered by earnings-per-share and is in no danger of being cut any time soon.
Altria stock has a very attractive dividend yield of nearly 4%. But its valuation leaves a lot to be desired. The company may struggle to produce enough earnings-per-share growth to justify its high valuation. Contraction of the valuation multiple would reduce total return potential moving forward.
Its dividend growth may be limited if its growth catalysts do not materialize.
That being said, Altria will still be able to sustain its current ~4% yield and grow the dividend at least by mid-single digits each year. As a result, Altria remains a very solid stock for income. Investors interested in the tobacco industry should also consider Philip Morris (PM) – which sells the Marlboro brand (and others) internationally.