Holding company of cigarettes and cannabis adapts to market trends while keeping operations highly cash-generative
New York-listed Altria Group is a holding company of multiple wholly-owned large subsidiaries that makes and sells cigarettes (Philip Morris USA), machine-made large cigars and pipe tobacco (John Middleton Co), smokeless tobacco products, and wine (Ste. Michelle). It also holds significant stakes in companies that manufacture oral nicotine pouches (Helix Innovations), e-vapour products (JUUL Labs), and in Cronos Group, which is a global cannabinoid company.
Altria’s reportable segments are smokable products, smokeless products, and wine. Since Altria is a holding company, its source of funds comes from its wholly-owned subsidiaries consisting of cash received from the payment of dividends and distributions, along with cash dividends from interest owned from non-wholly-owned subsidiaries. Altria derives close to 90% of its revenue from smokable products, 10% from oral tobacco products, and the rest from wine-related products.
Our case for Altria is that it is a dividend player with the ability to pay attractive and consistent dividends over the near to medium term. The company’s business generally has inelastic demand as its products are habit-inducing, as seen through its smoke and tobacco portfolio.
However, global trends involving consumer patterns for smoke-related products is changing, along with regulatory interventions, which affects traditional businesses that manufacture cigarettes. Adult smokers and tobacco consumers are increasingly seeking new options that reduce the negative effects of smoking, and Altria’s 10 year-vision plan addresses this by responsibly leading the transition of adult smokers to a non-combustible future, characterised generally with the so-called e-cigarettes product portfolio. This plan involves developing and expanding its portfolio of FDA-authorised, non-combustible products and actively converting adult smokers along with re-allocating resources from combustible to non-combustible products to maximise profitability.
This is widely acknowledged as a step in the right direction as global consumption volume of combustible products has seen a decline over the past five years, while the oral tobacco and e-vapour volume has seen growth. The diversification into cannabis through Cronos Group, which is also a safer alternative, would aid and supplement the business earnings in the near future.
The cigarette industry volume in the upcoming periods is expected to be influenced by trends such as adult smoker (AS) stay-athome practices, unemployment rates and the fiscal stimulus, regulatory and legislative developments such as excise taxes, timing and breadth of the Covid-19 vaccination deployments, and AS-purchasing behaviour post-Covid vaccination.
We believe Altria addresses these trends well in its business investment plans. These include investments to expand the availability and awareness of its non-combustible products in the marketplace, and managing costs associated with building an industry-leading consumer engagement platform that enhances data collection and insights, along with increased non-combustible product R&D expenses. This should ensure Altria’s profitability as it would be able to capitalise on these trends, and hence maintain its dividend rates.
In its latest FY2021 ended Dec 31, 2020, Altria performed well despite challenges from the Covid-19 pandemic. Net revenues including excise taxes were up 4.2% y-o-y, while adjusted diluted earnings per share increased 3.6% for the same period. The company has also authorised a US$2 billion ($2.66 billion) share repurchase programme to be completed by June 2022, which is expected to further contribute to shareholder value apart from dividend distributions. Dividends per share (DPS) also increased 2.4% y-o-y. With current dividend yields upwards of 8%, we think Altria would be able to maintain their dividend rates given its long-term objective of a dividend payout ratio of approximately 80% of its diluted adjusted EPS. Furthermore, we think Altria’s capacity to target a high payout ratio is largely supported by its modest capital spending, which has been around 1% of net sales on average for the past decade.
For the past 12 quarters, Altria’s financials have been solid, achieving positive operating income and cash flow. Margins, as at the most recent reported period, was strong at 51.1% and 38.1% for its operating margins and net income margins respectively. In terms of yields, the company is also relatively attractive compared to the US risk-free-rate of 1.2%. The earnings, operating cash flow and free cash flow yields are at 10.1%, 8.4% and 10.2% respectively. The company has decent short-term liquidity with a current ratio of 0.8 times and solvency-wise, although its debt levels are high, the interest coverage ratio of 7.8 times should be more than enough to keep the company as a going concern.
Compared to global peers, Altria trades at a discount with P/E and EV/Ebitda multiples of 27% and 8% respectively compared to the peer mean, denoting that it is relatively more attractive. Chart 1 illustrates the historical dividend yield of Altria, which has been growing consistently over the past 12 quarters, driven by both a fall in prices and higher dividends. The company’s debt leverage is also improving, as Net debt to Ebitda ratio dropped to 2.2 times compared to 2.4 times the previous year.
At first glance, this ratio might seem overwhelming, but this is high because of acquisition and significant investment costs to diversify from its non-combustible portfolio, like taking a 35% stake in JUUL labs in December 2018 and a 45% stake in Cronos Group in early 2019. The company remains confident it can maintain a strong payout ratio despite this, as its debts are mostly long-term and its current business is highly cash-generative.
Analysts have given a target price of US$49.13, which offers 15.7% upside potential from its current trading price of US$42.47. Even if the company reaches its fair value, dividend yields would still be around 7%, which is significantly more attractive than the risk-free rate. Altria is a great stock for investors seeking passive income through dividends, and we think the company is capable of maintaining the dividend value within attractive levels, at least over the short to medium term.
