With more than 1 billion smokers worldwide, it is hard to conceive that companies selling cigarettes would not be extremely profitable. In addition, the majority of people who are smokers also tend to be alcohol consumers. One company that services both of these vices is Altria Group Inc. (MO).
Altria Group is a holding company; its wholly owned subsidiaries consist of Phillip Morris USA Inc., U.S. Smokeless Tobacco Co. (prior to 2001 it was known as United States Tobacco Inc.), John Middleton Co. and Phillip Morris Capital Corp.
On Jan. 6 2009, Altria Group purchased UST Inc. in a $10 billion deal that gave the maker of Marlboro cigarettes an entrée into the "smokeless tobacco" market, thanks to UST's ownership of the Skoal and Copenhagen brands.
The UST deal bolstered Altria's position as a so-called "sin stock" in other ways, since Altria also acquired UST's wine business, Ste. Michelle Wine Estates (SMWE). Altria Group Inc. also owns a 27.3% stake in the second-largest manufacturer of beer, SABMiller PLC (SBMRY.PK).
In essence, Altria has become a one-stop shop for "sin."
In 2009, the Family Smoking Prevention and Tobacco Control Act went into effect, which allows the U.S. Food & Drug Administration (FDA) to regulate the production and sale of tobacco products. The law, in part, requires manufacturers to provide the FDA with a detailed summary of the ingredients used in smoking products. In order to achieve the law's objective, the FDA plans to impose a fee on manufacturers. While the impact of these fees and regulations may not be seen for years, manufacturers of tobacco products may actually see an improvement in their legal position over time.
And that could translate into higher profits and higher share valuations.
Let me explain.
As long as tobacco companies follow the new FDA standards, they will effectively be insulating themselves from future tobacco-related liabilities. Moving forward, tobacco companies could use the FDA regulation as a backstop against future litigation - resulting in an improved legal position.
In short, although new regulations are being imposed on tobacco manufacturers, it will be quite some time before the regulations will take effect, especially where the rules influence how tobacco is to be farmed.
The U.S. government will be setting strict guidelines with tobacco companies in order to keep teenagers and children from taking up smoking. In the future, tobacco companies will not be allowed to use their brands to sponsor music, sporting and other events. Moving forward, the FDA is expected to ban sales of cigarettes and smokeless tobacco in vending machines except in restricted circumstances. These same types of restrictions have been in place on hard alcohol for years - with very little real impact on sales.
Historically, the U.S. market has been a crucial one for such tobacco-makers as Altria Group and Reynolds American Inc. (RAI). But that's changing. As incomes rise in other parts of the world, sales of tobacco and alcohol-related products will rise as well, meaning the U.S. market is no longer the only profitable one for these firms.
In fact, considering that the number of smokers in China actually exceeds the total U.S. population, the rising regulatory oversight in the U.S. market is not a serious concern.
More to the point, Altria's Phillip Morris USA Inc. business unit is right now the only tobacco company to have signed a deal with China National Tobacco Corp. to sell Marlboro-branded cigarettes in China. That leaves Altria considerably less reliant on domestic U.S. sales.
In the 2009 fourth quarter, Altria said profits rose 7%, reaching 39 cents a share on an adjusted basis. Revenue rose 29%, totaling $6.01 billion. Excluding the federal excise taxes Altria collects, its quarterly revenue increased 7%, to $4.1 billion.
The company estimates that volume dropped 8% in the cigarette category and that it fell slightly in the cigar category. Altria's wine business witnessed an estimated increase of 10% in retail volume, which is significantly better than the 2% increase for the category as a whole.
The increase in wine sales makes sense in considering consumers may be looking for cheaper wine products - leaving Altria well positioned to profit from this shift in consumer preferences.
Overall, Altria's emerging blend of tobacco and alcohol products should diversify revenue - and protect top-line growth from any pullback in tobacco-related sales.
During Altria's fourth-quarter conference call, the company's top executives projected that its adjusted earnings per share (EPS) will reach $1.88 this year and $2.03 in 2011. Altria's forward-looking Price/Earnings (P/E) ratio (for the fiscal year that ends Dec. 11, 2011) is 10.58, and its "PEG" ratio (Price/Earnings ratio/Growth Rate) is currently at 1.39. Both of those ratios are low in relation to other companies in their peer group, which indicates that Altria shares are attractively priced in the tobacco sector.
Regarding its financial strength, Altria Group Inc. has seen its long-term debt increase from $7.14 billion in 2008 to $11.18 billion at the end of 2009. The company saw a drastic decrease in free cash flow (FCF) in 2009, which was attributed to losses in "cash flow from investment activities" booked in the first quarter of last year. Even with these two developments - the increase in debt and drop in FCF - Altria's management has indicated the company will still have enough cash on hand to maintain its industry-high dividend yield of 6.5% and to continue its effort to pay down debt.
Altria has a long commitment to dividend payouts, and has boosted its dividend annually in every year since 1970, with only two exceptions - in 2007 and 2008. The failure to increase the dividend in those two years was a direct result of the spinoffs of Kraft and Philip Morris International Inc. (PM). And, in both of those cases, the company issued special one-time dividend payments of $21.90 per share and $51.06 per share, respectively.
Historically, high-yielding consumer staple companies such as Altria provide a safe haven for investors when uncertainty strikes fear into the market. This gives Altria a possible advantage if we see weakness in the general markets in 2010 and 2011.
If you don't already own Altria shares, now would be a good time to start building a position. The company's revenue and earnings should continue to improve and the hefty yield will help smooth out any price volatility over the year.
While Altria may not perform like a small-cap biotech company that just received FDA approval for a new drug, its shares should offer "stability and growth" that historically has reduced portfolio risk and volatility while still leaving upside potential for growth - a great one-two punch for any portfolio.
Recommendation: "Buy" Altria Group Inc. (MO) and plan on assembling a position over the next four weeks to eight weeks, in order to limit current market volatility (**). As always, use a 25% trailing stop to reduce risk and capture profits.
(**) Disclosure: The writer holds no interest in Altria Group Inc.
updated May 03, 2010
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