There are two extreme camps of Altria’s (MO) future prospects. One of the camps is the bullish one which claims that Altria is a near monopoly, which has a 50.40% of the US cigarettes market and has nothing else to do with its cash than to distribute it back to shareholders in the form of dividends or share buybacks.
Given the fact that MO is not a growth company, the stock is spotting a P/E of 11 and a generous dividend yield of 7.8%. Some of Altria’s biggest fans also like to add that the company has increased its dividends for 42 consecutive years. Given the fact that 97% of stocks returns since 1871 have come from reinvested dividends, it is not surprise that this dividend growth tobacco stock was the best performer in the S&P 500 for the 50-year period from 1957 to 2007.
Even though tobacco sales are decreasing, most cigarette manufacturers could afford to offset sales declines by boosting price tags for its products. Since advertising tobacco products is illegal in the US, it would be almost impossible for newcomers to compete against Altria and erode its market share.
Another important asset that the US based Altria owns is a 28.5% interest in UK based SAB Miller, which is not only one of the largest brewers in the world, but also one of the largest bottlers of Coca Cola products worldwide. Altria’s stake is worth about 4.26 billion dollars per the company’s balance sheet as of 12/31/2008.
The Altria bears cite several reasons why one should not own stock in this tobacco giant. First of all the Altria that was the best performer in the S&P 500 is much different than todays Altria. The company spun out Kraft Foods in 2007 and Phillip Morris International in 2008. Without the growth of the international tobacco markets in the emerging market economies where Phillip Morris International has a dominant role and a lower probability of lawsuits, Altria is stuck with the US market, which is in a decline.
Another reason that Altria bears cite is that the integration of UST might cause liquidity problems for the tobacco conglomerate. Historically, the stocks stop increasing their payments to shareholders because they are saddled with debt after acquisitions in their field. Altria financed its UST acquisition by a bridge loan for 4.3 billion as well as a 6.8 bln in loans with maturities varying from 18 months to 30 years and coupons ranging from 7.125% to 9.95%. Altria intends to access the public debt market in 2009 to refinance the bridge loan borrowings with long-term debt.
Another risk for Altria is litigation, that could potentially wipe out the whole company. Since tobacco is a heavily taxed product however, a complete ban on its use will be detrimental for state and federal budgets.
The company recently announced its 4Q 2008 results, where its earnings per share from continuing operations were $1.48, unchanged versus 2007.
Given the current economic environment, Altria is suspending its $4.0 billion 2008-2010 share repurchase program, $1.2 billion of which was completed in 2008. Altria believes it is in the best interest of shareholders to preserve financial flexibility while it completes the financing of the UST transaction. This change gives Altria the opportunity to monitor economic impacts on its business and protect its investment grade credit rating. During 2009, Altria intends to focus on earnings per share growth and continuing its strong dividend policy. The company recognizes the importance of share repurchases to investors and intends to evaluate them again in early 2010.
I am bullish on Altria but only if one holds one share of Phillip Morris international for every MO share that they own. Altria has been successful in integrating very well companies it has acquired, so UST’s acquisition should be beneficial to shareholders. Furthermore tobacco companies are generally immune from economic fluctuations since smoking is a habit that is difficult to stop. It could be argued that during recessionary environments more people start smoking and less get the courage to quit.
One could always snap tobacco shares on the cheap, as many investors fear that an adverse litigation could potentially wipe out cigarette manufacturers. If this happen however, many states will lose billions in revenues from tobacco giants like Altria.
The high dividend payout is definitely a warning sign, which would hurt the growth of future dividend increases. If the company decides to go one step further after suspending stock buyback program until 2010 and cuts its dividends I will be the first one to head for the exits.
Full Disclosure: Long MO and PM
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