As many of you know, Altria (MO) has been one of my favorite high-yielding investments throughout the last year or so, due to its relatively cheap valuation in a market where most stocks with reliable dividend yields have been overbought by yield-thirsty investors. Throughout this T.I.N.A. (there is no alternative) market environment, I’ve been surprised to see MO be left behind. The fear associated with secular headwinds facing the heated tobacco space (and the tobacco space at large) have played a major role here. It appears as though certain investors expect to see Altria going the way of the dodo, with the near-single digit P/E ratio that has been applied to MO shares for much of the last year. MO has bounced back nicely from its recent lows in the $40 area. Even after today’s initial sell-off, shares are up roughly 18% since the lows the stock set back in September. But today, shares are sliding once again, down roughly 5.5% as I write this, in response to the company’s Q4/full-year report that it released this morning. In this piece, I’ll be breaking down the report and updating my fair value estimate on the shares.
Q4 net revenues came in just above $6 billion, which represented -1.8% growth y/y. Altria’s sales net of excise taxes came in at $4.8 billion, representing 0.3% growth y/y. The company’s reported EPS came in at negative $1.00/share during the quarter, due primarily to JUUL-related write-downs, it seems. The company’s adjusted EPS was $1.02, which represents 7.4% y/y growth.
For the full year, MO’s net revenues were $25.1 billion, representing -1% growth, y/y. The company’s revenues net of excise taxes came in at $19.8 billion, representing 0.9% growth y/y. Full-year adjusted EPS totaled $4.22, representing 5.8% y/y growth.
(Source: Q42019 CC Presentation, page 3)
During the report, MO provided updated full-year 2020 EPS guidance. Management expects to see 2020 EPS in the $4.39-4.51 range. This represents 4-7% y/y growth compared to 2019’s $4.22 figure.
Management also shed a bit of light on its EPS outlook further into the future. Now, MO is calling for 2020-2022 annual EPS growth to be in the 4-7% range. This is down slightly from prior 2020-2022 guidance in the 5-8% range. Management notes that it does not expect JUUL to make “quality earnings contributions” in the short term, which is why the forward-looking EPS CAGR has been slightly downgraded.
This 2020 guidance includes expectations for domestic cigarette volume declines in the 4-6% range. In Q4, domestic cigarette reported shipment volumes declined by 8.7%, y/y. However, when factoring in inventory movement and “other factors”, management estimated that domestic cigarette shipment volumes were down roughly 6% for the quarter. Industry-wide, MO estimates that cigarette shipment volumes were down 4.5%.
Full the full year, the company’s domestic cigarette shipment volumes were down 7.3% (and 7% after factoring in inventory data and other factors). Altria estimates that domestic shipments were down roughly 5.5% industry-wide for the full year.
(Source: Q42019 CC presentation, page 18)
The most concerning aspect of these falling volumes is the fact that MO’s results appear to be worse than the industry averages. The company’s relative weakness here is a problem that needs to be addressed moving forward.
Furthermore, although this represents a relatively small piece of MO’s business, cigar shipment volumes were up 4.6% in Q4 and 3.1% on the full year.
The company’s smokeless business saw growth in 2019 as well. Sales from this segment came in at $605 million during Q4 and $2.37 billion for the full year, representing 5.8% and 4.6% growth, respectively. Volumes in the smokeless space were down 4% in Q4 and 3.1% for the full year, yet higher prices and increased margins in the segment allowed MO to produce growth. Like in the tobacco space, its market share in the smokeless space fell by 0.1% in Q4 and for the full year, yet MO’s brands still represent total market share in the 53.9% range.
And lastly, the company’s wine business posted revenues of $206 million in Q4 and $686 million for the full year. In Q4, the wine segment’s sales were slightly positive y/y. Full-year results were essentially flat.
Obviously, it’s never good to see these sort of negative forces weighing on one of my holdings, but at the end of the day, I continue to marvel at Altria management’s ability to continue to produce bottom line growth in the face of these volume declines, and I continue to trust in their ability to do so in the future.
(Source: Q42019 CC Presentation, page 5)
With regard to relative strength compared to the rest of the domestic industry, MO reported that its Marlboro brand lost a bit of market share in Q4 and in the full-year overall. The brand’s market share was 43% during Q4 and 43.1% for the full year overall. Marlboro saw a 0.1% decline in market share during Q4 and FY2019. This means that MO continues to hold a strong market position, but I think investors should continue to monitor this slight trend moving forward.
With that being said, I think investors who own MO need to recognize the secular headwinds that the company faces and factor this into asset allocation decisions. Personally, I’ve increased my position in the company to the overweight area due to the attractive value that I’ve seen during the last 12 months or so. Right now, MO represents roughly 2% of my portfolio. If the post-earnings dip continues and shares fall back down towards the late-2018 lows, then I would be willing to add to my position again near previous support levels in the $40 area. However, barring that sort of wide margin of safety making itself available to me, I’m fairly content to sit tight here with my ~2% exposure.
JUUL Issues Persist
Probably the biggest headline news coming out of the Q4 report initially was the $4.1 billion impairment charge that MO took on JUUL. Right now, MO has reduced the value of its JUUL stake down to just $4.2 billion, compared to the $12.8 billion that it spent on the company a year ago. Obviously, this is terrible short-term performance. Management noted that legal cases pending against JUUL have increased by more than 80% since October 2019. On a positive note, MO did that say it expects to see an anti-trust resolution with regard to clearance in the first half of 2020.
MO and JUUL have updated the terms of agreement of their deal. Upon anti-trust approval, JUUL will restructure its board. These maneuvers include 2 directors appointed by MO, 3 independent directors, JUUL’s CEO, and 3 directors appointed by JUUL shareholders other than Altria.
In the Q4 report, management also said, “Altria has the option to be released from its non-compete obligation if JUUL is prohibited by federal law from selling e-vapor products in the U.S. for at least a year, or if Altria’s carrying value of the JUUL investment is not more than 10% of its initial carrying value of $12.8 billion.”
With regard to JUUL, MO CEO, Howard Willard spoke about the investment early on in the earnings report, saying:
“Despite the unexpected challenges related to our investment in JUUL, which led to impairment charges and reported losses, we made significant progress advancing and building our noncombustible business platform with the launch of IQOS and completion of the on! transaction. We enter 2020 with continued focus on harm reduction. We believe Altria’s enhanced business platform best positions us to succeed under various future category scenarios.”
Honestly, it seems as if he is trying to deflect attention away from JUUL’s performance and onto IQOS and on! To me, this is a bit concerning, because it seems to point towards a dire situation at JUUL. Due to the vaping illness issues that arose in 2019, I think most MO investors were aware of this. But I was under the impression that JUUL remained key cog in MO’s long-term growth plans. The dialog related to JUUL during the Q4 report appears to show management distancing itself a bit from the investment, which, at this point in time, has been an utter failure.
With that being said, it is worth noting that MO is still reporting growth in the e-vaping category in terms of volumes.
(Source: Q42019 CC Presentation, page 24)
Furthermore, JUUL is maintaining fairly strong market share in the industry, so, while there are plenty of issues at JUUL and in the vaping space at large, it doesn’t appear as though consumers are abandoning the brand or its products.
(Source: Q42019 CC Presentation, page 25)
Right now, in the $47.50 range, MO shares are trading for 11.25x TTM earnings and roughly 10.7x the mid-point of forward EPS estimates. These P/E multiples are well below the company’s long-term P/E average in the 14x area. As you can see on the F.A.S.T. Graph below, the current weakness in the share price has created what appears to be a significant bargain.
(Source: F.A.S.T. Graphs)
MO generated mid-single digit EPS growth in 2019, and analysts expect to see that trend continue through 2021. While the ~5-6% forward growth estimates are a bit lower than the high-single digit EPS growth that investors have become accustomed to throughout much of the last decade (I’m not factoring in the two big double-digit EPS growth years that MO produced in response to the Trump tax cuts in 2017 and 2018 here due to the one-time nature of their catalyst), I don’t think the slightly slower growth estimates should result in such a steep discount from historical average premiums.
I suppose that you could argue that ~6% is roughly 25% less than 8% and, therefore, the ~11x premium makes sense, since it is roughly 22% less than 14x. However, this relative comparison doesn’t take MO’s yield into account. To me, in today’s low yield environment, a high premium should be placed on the company’s yield, which is much more attractive than the yields provided by the S&P 500 and U.S. treasury notes (MO’s yield is more than 3x greater than the ~2.1% yield currently provided by the U.S. 30-year treasury note).
To me, in light of the historical averages, forward estimates, and recent news regarding the JUUL concerns, I think a 13x multiple makes sense when thinking about placing a premium on MO’s forward earnings. This represents a 2020 price target of $57.85 (for the sake of simplicity, I’ll round up to $58). That means I’m lowering my fair value estimate slightly. Prior to the recent report, my FV estimate was $59. However, $58 still represents 22% upside from here, which is why I’m happily long my overweight MO position.
To me, Altria’s strong dividend is the primary reason to invest in the name. Sure, the low valuation is attractive, but the company’s ~7% dividend yield is really nice. Furthermore, MO offers the unique combination of a high dividend yield plus dividend growth prospects in the mid-single digits. It’s rare that high-yielding stocks allow me to meet my double-digit Chowder Number target, because typically, high yielders offer growth in the low-single digit range. When I’m thinking about high yield stocks, I usually cast that Chowder Number target aside, focusing on the defensive quality of the income rather than growth. Generally, my expectation for yields above 4% are for growth to exceed inflation. So long as this happens, I’m generally content, but MO exceeds those expectations by a wide margin.
In late 2019, MO increased its quarterly dividend from $0.80/share to $0/84/share, representing 5% growth, y/y. This increase marked the company’s 50th consecutive annual increase. In other words, Altria is a Dividend Aristocrat, and even though cigarette volumes are falling, I don’t expect to see this trend end anytime soon.
During the Q4 report, management set expectations for future dividend growth saying:
“Altria expects to maintain a dividend payout ratio target of approximately 80% of adjusted diluted EPS for the years 2020 through 2022. Future dividend payments remain subject to the discretion of Altria’s Board of Directors (Board).”
This ~80% payout ratio is in line with historical results. Right now, MO’s payout ratio, on a forward-looking basis relative to the mid-point of the updated guidance that the company provided, is 75.5%. This implies that the company has ample room for another mid-single digit dividend raise in 2020, which would be fantastic considering the current dividend yield is already so high at roughly 7.1% due to the post-earnings sell-off.
As you can see on the F.A.S.T. Graph posted above, not only do analysts currently expect 2020 EPS growth to be in the mid-single digits, but they have similar expectations for 2021 as well. Analyst consensus for 2020 is in line with the $4.45 mid-point of the updated company guidance. This gives me confidence that the expectations of $4.72 in EPS during 2021 can be met as well.
MO’s cash levels increased to $2.12 billion at the end of the recent quarter (up from the $1.33 billion level a year ago). The company’s long-term debt increased significantly compared to the figure a year ago (due primarily to the ~$13 billion JUUL investment that MO made in December of 2018 and the ~$1.8 billion investment that it made in Cronos in early 2019). At the end of the recent quarter, the company’s long-term debt was roughly $27 billion compared to nearly $12 billion a year ago). MO maintains an investment grade credit rating (S&P currently gives the company a BBB rating).
I know that MO bears will continue to focus on the declining volumes and JUUL headwinds. Yet, I choose to focus on the reliable bottom line results and the strong, safe dividend that MO offers shareholders. To me, it appears as though there is a major disconnect between the company’s valuation and its fundamental results. MO appears to be priced as if it is in dire straits, yet, as noted above, full-year revenue growth was slightly positive and EPS growth was up 5.8%. To me, that doesn’t signal a failing company. On the contrary, I think it makes MO an attractive value investment.
As noted in the introduction, a T.I.N.A. market rages on. While MO shares were falling this morning, the utilities hit all-time highs. It’s clear that investors are piling into defensive, income-oriented equities in a flight to safe havens. This has pushed valuations in most high yield industries to levels well above historical averages. Yet, tobacco names remain in the bargain basement. Personally, even with the headwinds and the JUUL issues at hand, I’d rather buy shares of MO near a 10x forward multiple rather than the 23.7x multiple that is currently being placed on the Vanguard Utilities ETF (VPU). Secular headwinds continue to be a concern, but at the end of the day, the relative valuation here represents a margin of safety that I can’t ignore.
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Disclosure: I am/we are long MO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.