A number of analysts have recently revisited their ratings on Altria (NYSE:MO), and this might be an appropriate time to take a fresh look at Altria as a candidate for potential investment. Equity researchers at Davenport have upgraded their rating from "hold" to "buy", while Zacks has reaffirmed its rating of neutral. Wells Fargo analysts have upgraded their rating from "market perform" to "outperform", and the Jefferies Group has set a "hold" rating on the stock.
Altria is actually a holding company for the tobacco company Philip Morris and also sells wine which reduces its dependence on the tobacco business. It also owns more than a quarter of the brewing giant SAB Miller (SAB) which has popular brands like Blue Moon, Coors Light, Miller Genuine Draft and Miller Lite. Despite this diversification, its bread and butter business continues to be tobacco where its flagship Marlboro has over 40% of the cigarette market in the U.S. and over half for its smokeless tobacco products. Other popular cigarette brands include Virginia Slims, Parliament and Benson & Hedges.
All of its products and businesses — because they involve tobacco and alcohol — are referred to as "sin" products. In view of the increasing concerns about health, neither cigarettes or alcohol can be described as growth products in the developed world though markets in the developing world are still demonstrating growth.
Many investors do not like investing in sin companies because of their moral and ethical objections to cigarettes and alcohol. Plenty of investors simply refuse to invest in such companies and paradoxically, these perceptions together with concerns about the decline of smoking as well as the plethora of class-action lawsuits against the industry lead to an undervaluation of the stock.
As Altria's consistent and profitable performance over the past so many years demonstrates, their customers love these products and are obviously prepared to pay premiums that protect the operating margins and compensate for declining revenues. It also means that the company is in the fortunate position of generating predicable and stable earnings and cash flows.
From a purely investment point of view, without participating in the debate about the ethics and morals, I consider it abundantly clear that there is a lot of money to be made out of the sin market. Ironically, you would have been much better off investing in Altria as compared to any number of companies that cater to health and fitness markets.
One of the most compelling reasons to invest in the company is its status as a dividend king. A dividend yield in excess of 5% on a continuous and predictable basis is a rarity in the equity markets and equity investors who are fed up of the gyrations in the equity markets in general should be greatly comforted by the long-term dividend yield to be expected as well as the low Beta which shows that the stock price is much less volatile than the market as a whole. As we have already noted, despite the declining revenues in the developed world, the ability of the company to maintain the dividend is not in doubt for the foreseeable future.
If you turn your attention to the market and the competition, it is worth noting that there are only three major participants in the tobacco markets in the U.S., namely Altria, Reynolds American (NYSE:RAI) and Lorillard (NYSE:LO), apart from a few much smaller players. This is likely to continue to be the situation as far as one can see into the future because the entry barriers caused by regulation as well as the huge potential legal liabilities will ensure that there is little or no meaningful competition that can be developed. Altria also happens to be the most diversified of the major players. Reynolds is expected to post flat growth in 2012 with a modest increase in earnings after accounting for share repurchases. Lorillard is expected to show earnings growth in excess of 10% because of its larger expected share repurchases. It is worth noting that Lorillard is a higher-risk investment because of its excessive dependence on menthol cigarettes and the brand Newport. Menthol cigarettes are considered by the regulatory and health authorities as being more harmful to your health.
The investment is by no means perfect and there are several areas of concern. All the major players continue to be plagued by class-action lawsuits but there is a silver lining in this cloud. I believe that, after the passing of many years, the legal problems would be resolved in the near future and there have already been a number of rulings favorable to the industry.
In addition, it seems to me that public resentment against the tobacco companies has decreased significantly and they are no longer seen as the outright villains which could mean a slightly more favorable climate for investor sentiment in the tobacco industry. There is also continuing pressure for smoking laws that are more strict, but Altria should be able to protect its operating profits through price increases if necessary.
Though it is well known that Altria has a high dividend payout rate, it is not as well known that its cash holdings will cover about a quarter of its debt. Its major competitors have much better cash coverage for their debts. It is true that price increases can compensate for declining revenue but there is a limit to which prices can be increased. However, as I have noted, there is no reason why the dividend payout should not be maintained in the years to come. Another problem is that all of Altria's business comes from the U.S., and it has no real penetration in other markets which are experiencing growth. This means that if you believe that the real prospects for tobacco companies lie outside the U.S., you are probably better off with international tobacco companies like British American Tobacco (BTI).
I should also point out to you that of the three U.S. tobacco majors, despite the more diversified nature of its business, Altria is the cheapest in terms of valuation. In conclusion, I would recommend a hold if you have an existing investment but, if were you, I would keep a close watch on the developments in the industry because any suitable event could present a good buying opportunity.
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