It has been a tough month for tobacco stocks. The Federal Reserve has signaled its intention to aggressively raise interest rates, which has impacted the bond equivalent stocks. Most of the tobacco companies have large dividend yields, which have been attractive in a low-rate environment. That could be changing as rates move higher.
In addition, Russia's invasion of Ukraine has made many corporations reconsider doing business in the former country. For some, this means a cessation of production within Russia or the stopping of selling products altogether.
Decreased exposure to Russian markets is going to have a meaningful impact to many in the tobacco industry as a result. This has put additional pressure on the top names in the sector. For example, Philip Morris International Inc. (PM, Financial), Imperial Brands PLC (IMBBY, Financial) and British American Tobacco PLC (BTI, Financial) have fallen 13.6%, 10.5%, and 8.8% in the past month.
For those looking for an investment in and income from the industry, the options are somewhat limited. However, there is one name with zero exposure to Russia, or anywhere outside of the U.S., and that is Altria Group Inc. (MO, Financial).
Altria is up 1.7% over the past month, which is considerably better than the returns for the other top tobacco names. I will examine why income-oriented investors seeking exposure to the tobacco industry should consider taking a look at the company.
Company background and results history
Altria was founded in the mid-1800s and has grown to be one of the top tobacco companies in the world. After spinning off Philip Morris in early 2008, the company is completely focused on selling its products in the U.S. Aside from traditional, heated and smokeless tobacco products, Altria also has investments in Anheuser-Busch InBev (BUD, Financial) and Cronos Group (CRON, Financial). The company is valued at close to $94 billion and has annual revenue of $21 billion.
The company reported fourth-quarter and full-year 2021 earnings results on Jan. 27. For the quarter, revenue fell 0.8% to $6.3 billion while adjusted earnings per share of $1.09 compared favorably to 99 cents in the prior-year period. Both figures were slightly ahead of what Wall Street analysts had anticipated.
For the year, revenue decreased 0.5% to $26 billion while adjusted earnings per share of $4.61 were ahead of $4.36 in the prior year.
Revenue has a compound annual growth rate of just 0.6% over the last decade, due in large part to declining smoking rates. That said, Altria’s earnings per share have a CAGR of 9.4% over this same period.
Share repurchases have been a factor in this growth as the company has retired an average of 1% annually since 2012. Much of the earnings per share growth can be attributed to the improvement of the net profit margin rate of 17% in 2012 to more than 32% last year.
Dividend growth history and recession performance
Altria’s business has held up successfully for long periods of time. Even as the tobacco market has been in perpetual decline, Altria’s ability to efficiently extract profit from its business has allowed the company to raise its dividend for 52 consecutive years. This places the company among the Dividend Kings, of which there are just 40 companies with the minimum of five decades needed for membership.
The company’s dividend has a 10-year CAGR of 8.4%. Most recently, leadership announced a 4.7% dividend increase for the payment made last July 9. Shares yield almost 7% today, which compares to the stock’s average yield of 5.4% for the last decade.
Altria has such a long dividend growth history because its business model has worked under all manner of economic conditions.
This includes recession. Altria completed its spinoff of Philip Morris in the midst of the Great Recession, so the 2007 to 2008 comparison isn’t apples to apples. That being said, listed below are the company’s adjusted earnings per share for the 2008 to 2012 time period:
- 2008 adjusted earnings per share: $1.66
- 2009 adjusted earnings per share: $1.76 (6% increase)
- 2010 adjusted earnings per share: $1.87 (6.3% increase)
- 2011 adjusted earnings per share: $1.64 (12.3% decrease)
- 2012 adjusted earnings per share: $2.06 (25.6% increase)
Altria saw its adjusted earnings per share grow from 2008 to 2009 despite the market conditions. The company did see a dip below what it produced in 2008, but quickly made a new high the very next year. Adjusted earnings per share have increased year over year every year since then.
The dividend also continued to grow as the company extemded its long streak of rewarding shareholders with increases each year.
Looking at a more recent example, Altria navigated the Covid-19 pandemic quite well. For 2020, revenue grew 4.2% and adjusted earnings per share were higher by 3.3%. Adjusting for the share count, the net profit was up almost 3% for the year. The company’s divided grew 2.4% in 2020, well off what the average raise has been. Considering the uncertainty of the time, this was arguably a prudent raise.
Between the performance in the last recession and the company’s ability to weather the worst of the pandemic, Altria has proven over time the resiliency of its business.
Payout ratios' impact on future dividend growth
Long dividend growth histories don’t mean much if future growth is impaired. This is why it’s always important to consider the payout ratios to see if dividend growth will continue.
Altria paid out $3.52 in dividends per share last year, leading to an earnings payout ratio of 76%. This is high in a vacuum, but actually below the company’s 10-year average payout ratio of 80%.
Let’s turn to the free cash flow payout ratio now. Altria distributed $6.4 billion in dividends in 2021, while generating free cash flow of $8.2 billion for a free cash flow payout ratio of 78%. Again, this is higher than some might be comfortable with, but it is very close to the three-year average free cash flow payout ratio of 74%.
Altria’s earnings and free cash flow payout ratios are elevated, but leadership has stated its intention to return as much capital to shareholders as possible by way of dividends and share buybacks. Therefore, the payout ratios might mean lower dividend growth in the future, but likely won’t be a headwind in Altria extending its dividend growth streak.
The impact of debt of dividend security
Lastly, we will examine Altria’s debt obligations to see if they will be an obstacle to future dividend increases.
Interest expenses totaled $1.2 billion last year. With the company having total debt of $28 billion at year’s end, Altria has a weighted average interest rate of 4.3%.
The chart below presents a visual representation of how high the weighted average interest rate would need to be before free cash flow no longer covered dividend payments.
Source: Author’s calculations.
As seen above, Altria’s weighted average interest rate would need to rise above 10.6% before dividends weren’t covered by free cash flow. This is one of the lower thresholds of the stocks that I cover, but there appears to be a sufficient enough buffer that the dividend looks safe when considering the impact of debt on future growth.
Final thoughts
Tobacco companies with a presence in Russia have seen their stock prices suffer a steep decline in a short period of time. In contrast, Altria, with its focus on the U.S., has actually gained ground over the last month. Bond proxy stocks are also likely to take a hit as the Federal Reserve raises interest rates.
Altria has no Russian business, keeping the company safe from issues related to that market. The company's high yield looks to be safe using either the earnings or free cash flow payout ratio. Debt also doesn’t seem to be a headwind to future raises either.
For investors looking for exposure to tobacco without the risk related to Russia, as well as a high and secure dividend yield, Altria could be an enticing option.
