Altria Group, Inc. (NYSE:MO) continues to see weakness in its share price, not surprising given the company’s primary source of strength is its dividend. In a rising interest rate environment, the company with a reliable dividend yield it’s paid out for decades is now approaching a double-digit yield. However, when your largest business is in decline, it’s a tricky situation.
As we’ll see throughout this article, Altria has the ability to drive shareholder returns, but it remains tricky.
Altria Financial Results
The company had reasonable results for the year so far, however, it continues to operate in a tough industry.
The company has a share price of $40/share, and EPS for the 9 months YTD was $3.78/share. Annualized, that’s roughly $5 per share in EPS for the company. The company’s EPS has increased by 3.3% YoY, less than inflation, showing the tough pricing environment. The industry has continued to suffer, and a hurting middle class has hurt the company’s ability to raise prices.
The company is working to continue de-risking its profile, which is a strength worth paying close attention to.
The company has seen strong consistent volume in the oral tobacco industry, helping to offset part of the losses from declines in the company’s traditional industry. Shipment volume has increased dramatically from 21 million cans a year ago to 28.7 million cans in the most recent quarter. We expect the company’s volumes to continue their growth.
At the same time, the company has been drastically ramping up retail prices per can. The company’s increase in retail price has increased by more than 50% YoY, helping to highlight its consistent pricing power. The company has maintained strong repeat purchases with strong trial conversion, and we expect that ramp-up to continue.
There are a few things to note here.
The first is one of the largest benefits of heated tobacco products is they’re much less dangerous than cigarettes. Pure nicotine is less dangerous than smoking. In Altria’s perfect world, the long-term harm of nicotine would be nothing, and the addiction excitement, etc., would still be there. Look at how popular caffeine is as an addictive.
The second is that nicotine etc. is much cheaper to produce and sell than cigarettes. At the same time, there’s more pricing power than cigarettes because of perceived health benefits. That combination means that the company can extract much higher margins from the business helping to offset industry decline.
A Dying Industry
The company has continued to see its business decline.
It blames a substantial part of this on macroeconomic factors. High budgets forced customers to cut back and cigarettes were a great black to cut back. Being a pack-a-day smoker is expensive. Cigarette price elasticity as the company raised prices was also part of that, and the company puts the net secular decline rate as very low.
The reality of the matter is once the decline happens, it doesn’t matter what it’s attributable to. It’s there. We expect with lower inflation rates, the industry decline rate will go down, but that decline rate is still a sign of a dying industry that will continue to hurt the company.
Long-Term Shareholder Value
At the end of the day, the question becomes how a company with $24 billion in long-term debt can drive long-term returns.
The company has a single-digit P/E and uses the majority of its cash for shareholder returns. At current prices, its dividend is just under 10%, and the company has raised its dividend by 4%. It plans to continue raising. The company is slowly repurchasing shares, but it’s continuing to repurchase ~1.5% of its float annually.
The strength of the company’s long-term returns, along with its overall decline rate shows the company’s business strength. The company continues to have several assets including more than 15% of its market cap in Anheuser-Busch InBev SA/NV (BUD) that it could sell and use to pay down debt or improve its portfolio.
In the short term, we expect strong shareholder returns to outweigh long-term risk.
The largest risk to our thesis is whether Altria can succeed over the long term with an industry in secular decline. There’s no denying that industry decline rates will remain strong, regardless of whether the company attributes it to macroeconomic factors or something else. That industry decline could substantially hurt the company’s share returns over the long run.
Altria has an impressive portfolio of assets and the company remains a cash flow giant. The company continues to maintain its dividend of almost 10% which it can comfortably afford and continue to raise it. While the company has made a few poorly timed investment decisions over the past few years, it’s still a great investment.
More so, the company does have some catalysts. The shift to heated tobacco will likely increase margins. At the same time, declining interest rates will likely decrease secular decline. That combination will enable the company to maintain and grow shareholder returns, making it overall a good investment. Let us know your thoughts in the comments below!