Published January 26th, 2017 by Bob Ciura
The tobacco industry is dominated by two companies: Altria Group (MO) and Philip Morris International (PM).
Both companies came from the same beginnings, but were separated in 2008. Altria spun off PM, and the companies have traded independently of each other ever since.
Altria operates the Marlboro brand in the U.S., along with a number of cigar, chewing tobacco, and wine businesses. PM operates the Marlboro brand outside the U.S.
And, both stocks are consistently high paying dividend growth stocks. Altria is a Dividend Achiever, a group of 272 stocks with 10+ years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Investors might assume the companies are still one and the same, but they have several different products, and face a unique set of challenges going forward.
This article will discuss four reasons why I prefer PM over Altria.
Reason #1: Dividend Yield
First and foremost, PM has a higher dividend yield than Altria. PM has a current dividend yield of 4.4%. Meanwhile, Altria’s current dividend yield is 3.4%.
This might not seem like a significant difference, but a full percentage point really makes a difference over time. Put differently, PM offers investors approximately 29% more income than Altria.
To be sure, both companies are excellent dividend stocks. Altria has increased its dividend 50 times in 47 years.
But PM is no slouch when it comes to dividend growth. Since the 2008 spin-off, PM has increased its regular quarterly dividend by 126% from the initial annualized payout of $1.84 per share.
The main reason for the difference in the companies’ respective dividend yields is because of their share price performance. Altria stock rose 147% in the past five years; PM stock is up 24% in the same period.
PM has not enjoyed nearly the same share price appreciation, because it is suffering from a very difficult foreign exchange market.
PM’s dividend growth has trailed Altria’s over the past few years, but this is mostly due to currency impacts.
The strong U.S. dollar has wiped billions off of PM’s annual revenue. This has made it harder for the company to increase its dividend at higher rates, and it is the reason why investors have not bid up the share price to the extent of Altria.
However, foreign exchange markets tend to revert to the mean over the long-run. The strong U.S. dollar won’t last forever.
Plus, PM has a better long-term trajectory. PM has some fundamental advantages that should result in stronger revenue, earnings, and dividend growth moving forward.
Reason #2: International Growth
The second reason I prefer PM over Altria is because PM has more growth potential, because of its international focus.
Altria generates 100% of its revenue from the U.S. This has sheltered the company from the strong U.S. dollar, which is hurting PM right now.
For example, unfavorable currency fluctuations decreased PM’s revenue by $4.7 billion in 2015.
International exposure is hurting the company now, but will likely be a net benefit for PM over the long run.
The U.S. tobacco market is virtually saturated, and is slowly deteriorating. The smoking rate is declining in the U.S., especially among young consumers.
Source: Annual Shareholder Meeting, page 24
Altria’s U.S. cigarette volumes declined 2% through the first three quarters of 2016. PM expects full-year volumes to decline 1% in its biggest market, Europe.
This has resulted in slightly stronger revenue growth for PM. Excluding excise taxes and currency, PM’s revenue rose 2.5% over the first three quarters of 2016. Altria’s revenue excluding excise taxes increased 2.2% in the same period.
Adjusting for currency, PM expects earnings-per-share to grow 10.5%-11% for 2016. Altria expects a more modest earnings growth rate in 2016, of 6.5%-8.5%.
With such a difficult backdrop of falling smoking rates, growth in the U.S. is going to be hard to come by for Altria over the long term.
The company has responded to this challenge by broadening its product portfolio beyond cigarettes. But even so, Altria still generates approximately 90% of its profit from smokeable products.
PM has staked itself a significant lead in reduced-risk products like e-vapor, which are latching on with consumers more in the international markets than in the U.S.
Reason #3: Reduced-Risk Products
PM has bet its future on its iQOS product line, which the company refers to as reduced-risk products. iQOS is the result of 10 years of study, and $3 billion of research and development spending.
With less regulatory red tape to cut through in international markets, iQOS is already available in 13 countries outside the U.S.
PM is seeing strong growth in the category.
Source: Morgan Stanley Global Consumer & Retail Conference, page 7
The iQOS product was initially launched in Japan, and PM’s market share soared. From April-October 2016, PM’s market share of Heatsticks more than tripled.
PM’s heated tobacco stick shipment volume reached 2.1 billion units last quarter, up approximately 900 million units from the same quarter last year.
Altria does have a similar product line, under the MarkTen brand. It owns the rights to the iQOS line in the U.S.
Source: Annual Shareholder Meeting, page 28
But the U.S. is a much harsher regulatory environment, which has slowed down Altria’s progress in e-vapor.
Altria’s next generation of iQOS Heatsticks has still not received final approval from the FDA. Nationwide roll-out is expected to come in 2017.
Reason #4: Valuation
Lastly, PM has a cheaper valuation than Altria. PM stock trades for a price-to-earnings ratio of 23. It is valued at a discount to the broader indexes. The S&P 500 has an average price-to-earnings ratio of 25.
For its part, Altria stock has a price-to-earnings ratio of 27. As opposed to PM, Altria is valued above the S&P 500.
PM could still have room for multiple expansion, especially if the brutal currency headwind eases. Earning a market multiple would boost shareholder returns.
As a result, PM stock appears to be slightly undervalued, while Altria could be considered fairly valued.
If PM stock were to trade at a price-to-earnings ratio of 25, it would generate a 9% return from multiple expansion.
By contrast, if Altria stock were to trade down to a market multiple, its share price would decline approximately 7%.