Why Altria could be an Exciting Investment Opportunity

Altria has the potential to provide dependable earnings growth which could provide an exciting investment opportunity. This is due to the leadership of their primary business and the pricing power of cigarettes in the United States. Additionally, Altria’s stock price is depressed due to challenges with recent acquisitions and slow transition away from cigarettes. Based on this, I would rate Altria 4/5 stars for quality and 4/5 stars for valuation.

• Highly regulated primary combustible business with strong pricing power in the United States that could provide dependable long-term cash flows
• Positioned for new strategic partnership and cash infusion from Phillip Morris International
• Boasts a great valuation due to a low price to earnings ratio and potential for stable earnings growth

• Has higher debt following a number of potentially problematic acquisitions
• Challenges with core business in long-term decline with limited new categories

Business History and Overview:

Altria is one of the largest tobacco companies in the world that produces and markets tobacco or related products. Starting in 2008, Altria became a primarily US based company following spinning off Kraft Foods and Phillip Morris International.

Altria faces criticism due to the dangerous health hazard associated with their combustible products. This has led to Altria planning to transition away from cigarettes to potentially less harmful products by 2030.

The company currently operates through the following reportable segments:

1) Smokeable tobacco products: Involves manufacturing and distributing cigarettes including Marlboro, the best selling cigarette brand in the US. Altria also manufactures and sells cigars including Black & Mild.

2) Oral tobacco products: Involves the manufacturing and selling of moist smokeless tobacco products including brands like Copenhagen, Skoal and Red Seal.

Business Quality:

One of the strengths of Altria is that the company has a long history of consistent and dependable income.

Smokeable products (i.e. cigarettes and cigars) is by far Altria’s most profitable business. Altria offers a range of cigarettes including premium brands like Marlboro, Virginia Slims, Parliament, Benson & Hedges and Nat’s. They also sell discount brands including L&M, Basic and Chesterfield.

Many of these cigarettes are also popular, with Marlboro currently having over 58% of the US premium cigarettes market share. While smokeable products have seen about an 8% growth in operating income over the last decade, the volume of sold smokeable products have steadily decreased:

As we can see above, the volumes of smokeable products have been decreasing annually by over 3% on average. A large part of this decrease is due to initiatives to increase awareness of the dangers of smoking (currently the leading cause of preventable death) and reduced cigarette usage. However, Altria’s ability to increase cigarette prices have allowed smokeable products to continue to grow in profitability despite the decreasing volumes.

The oral tobacco products also have about 8% growth in operating income, though the volumes have been much more stable:

The oral tobacco products include the popular on! brand, which has almost 23% of the US oral nicotine pouch market. These products are also more profitable than the traditional smokeable products, as the operating margins are at an impressive 82% (compared to smokeable products which have about 45.5% operating margin). A large part of this higher operating margin is due to lower excise tax of the oral tobacco products.

Altria also have key investments in Anheuser-Busch InBev (brewing company), Cronos (cannabis company) and Juul (electronic cigarette company). In particular, Juul has been noteworthy as it has arguably been one of the worst acquisitions in corporate America. Altria acquired Juul for $12.8 billion in 2018 and, since then, Juul has come under scrutiny for their role in underage vaping, anti-trust actions by the free trade commission. Juul is now estimated to have a carrying value of $450 million.

In terms of quality of Altria’s business, I would rate the company as high quality (4.0 out of 5 stars). I believe that Altria is well positioned as a leader in the highly regulated US tobacco industry. In particular, Altria boasts high profitability and dependable cash flows from their tobacco businesses. Part of this profitability comes from how cheap cigarettes are produced compared to their manufacturing cost. Altria has also increased their dividend for 52 years and currently has a nearly 8% dividend yield.

One of my main concern with Altria is that their primary business has been in decline. Over the last few decades the decreasing volumes of smokeable products has been offset with increasing cigarette prices, though many question how long price increases can continue to drive future profits. This has led Altria to develop noncombustible products to replace their traditional cigarettes. In particular, Altria started a collaboration with Japan Tobacco to sell their new heated tobacco device Ploom X in the US. However, oral tobacco product growth has been slow and Ploom X is not expected to receive FDA approval until 2025.

Another concern with Altria is their debt ($23.8 billion net debt). However, their operating income is 10X higher than their current interest payments and they have a good credit rating of “BBB” from FitchRatings. Altria is also exiting their partnership with Phillip Morris International and will receive $2.7 billion in cash. This cash infusion into Altria and new partnership with Japan Tobacco could help Altria reduce some of this debt.

Valuation:

Altria’s stock underwent a major correction from 2017 to 2019, with the forward PE ratio currently down to under 10X.

However, despite this correction, I believe that Altria is still positioned to grow their earnings throughout this decade. In particular, I believe that Altria’s smokeable segment still has room to grow via increasing cigarette prices. My reasoning for this is below:

1) Although Marlboro cigarette prices have increased in the US (about $8), the cost is still relatively more affordable than other developed countries like France ($11.7), the UK ($15.62) and Australia ($26.29) as of 2021.

2) The average Marlboro pack used to be about $6 in 2014 in the US. This means that the price of a Marlboro pack has been increasing by about 5.5% over the last 6 years.

3) Assuming that this price increase trend holds moving forward, it will take about 6 years for the pack of Marlboro in the US to cost the same as it does currently in France and about 12 years to reach the current price of a UK Marlboro pack.

Let’s also assume that declines in the volume of smokeable products decreases by 4.5% based on recent declines. Thus, I think that smokeable products will have earnings growth of about 1% per year over the next five years. I will also assume that the noncombustible products will not have any earnings growth over the next five years. This is likely overly pessimistic as the oral tobacco business is very profitable, has been slowly expanding over the last few years and the partnership with Japan Tobacco could open new opportunities for growth (likely starting after 2025).

Let’s also assume that Altria will return $1 billion in share buybacks annually, which close to their average stock repurchases. This hypothetical scenario would lead to about a 2.25% growth in earnings per share (EPS) (1% from the smokeable products and 1.25% from share repurchases), which has the potential to lead to excellent returns:

If these assumptions are correct, then at the current share price Altria could have the potential to deliver a significant nearly 13% compounded returns over the next five years. Interestingly, Yahoo finance currently predicts that Altria will have even higher long term growth of about 4.16% growth per year. Based on this analysis, my opinion is that Altria should receive a 4.0 out 5 stars for valuation.

Risks:

Investing in Altria does come with a number of potential risks. As mentioned earlier, cigarettes are currently the leading cause of preventable death. This has led to significant regulations on tobacco sales from the FDA, federal, state and local authorities. Additionally, tobacco companies face major lawsuits, including the master settlement resulting in over $206 billion of costs to tobacco companies. Tobacco companies are also heavily taxed by the government via excise tax, and these taxes could increase across Altria’s entire portfolio. Finally, retailers like Walmart, CVS and Target no longer sell cigarettes in some stores.

Conclusion:

The overall negative sentiment towards tobacco companies, and Altria in particular, has created what I believe is a buying opportunity. Based on my growth estimate – which I believe is fairly conservative – Altria could have the potential for some strong returns. In fact, I would argue that at the current price investors are purchasing the smokeable products business relatively cheap and receiving any growth in noncombustible products for free.

I also believe that the quality of Altria’s business is very good. This is due to Altria’s consistent cash flows, high margins and the regulatory requirements to enter the tobacco space. However, the declining core business, slow transition away from cigarettes and somewhat recent Juul acquisition debacle lowers my quality rating to 4 out of 5 stars.

From my perspective, I think Altria potentially offers a strong business at a real bargain. For my portfolio, I will consider Altria a strong buy under $43.50 and a moderate buy under $48.50.

Disclaimer:

I currently own stocks mentioned in this article including Altria and British American Tobacco stock at the time of writing this post. Additionally, I am not a financial advisor and I am not providing financial advice. I am sharing my thoughts and processes of selecting stocks for my personal portfolio for fun and entertainment purposes only.

All information provided here is on a “best of my knowledge” basis and may be incorrect. All estimates and models are guesses and may not be accurate. Stocks mentioned here may have additional risks not covered in the post.

Investing in the stock market comes with serious risk of losing money, please consult a professional financial advisor and do due diligence before investing.