The marijuana industry has seen some rapid expansion in recent years. Much of this growth is related to the legalization of marijuana in several countries.
Source: Cannabis Business Times
While not yet legal in the U.S. on a federal level, 33 states in the U.S. have legalized marijuana for medical purposes while another dozen have decriminalized or reduced criminalization for recreational use of the substance. The trend is likely to continue going forward, which could give rise to a potentially significant investment opportunity.
Currently, there are more than 140 marijuana stocks that investors can choose from, but there are very few pure play companies that offer dividends. Investors looking for income from this sector will likely have to choose from one of several dividend paying companies that offer indirect exposure to the marijuana industry.
One of our favorite dividend paying companies that offers indirect exposure to marijuana is Altria Group (MO).
Company Background & Marijuana Exposure
Altria was founded by Philip Morris in 1847. Today, Altria is one of the largest tobacco companies in the world, but sells its flagship Marlboro brand and other products in just the U.S after spinning off international business in Philip Morris (PM) in 2008.
Altria has a number of non-smokeable brands, including Skoal, Copenhagen and the Ste. Michelle brand of wine. The company also owns a 10% stake in Anheuser-Busch InBev (BUD) and a 35% stake in e-cigarette market Juul. Altria trades with a market capitalization of $89 billion, with annual revenues of $20 billion.
With cigarette usage declining in the U.S. for quite some time, Altria has had to explore new avenues in order to grow. With marijuana decriminalization starting to take hold, it naturally makes sense for the company to enter into this sector.
In December 2018, Altria invested $1.8 billion in Canadian marijuana company Cronos (CRON). This investment gives Altria a 45% stake in a global leader in the marijuana industry. Altria has an option to acquire another 10% of Cronos as well.
If and when marijuana becomes legalized at the federal level in the U.S., Altria will be able to use Cronos’s diversified business and know how to quickly pivot to become a leading provider of the substance.
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Recent Earnings Results
Altria reported second quarter results on 7/30/2019. The company earned $1.10 per share, in-line with estimates and flat from the same quarter a year ago. Revenue grew 6.4% to $5.2 billion, which was $115 million higher than expected. Much of the company’s revenue increase was due to higher prices.
Altria’s smokeable products shipment volumes increased 0.3%, well above an expected drop of 10.6%. Revenues net of excise taxes were up 7.4%.
Marlboro volumes improved 1.1%, which was impressive given that this brand had a 13.5% decline in the first quarter of the year. Marlboro represented 86% of total smokeable volumes for the company and maintained a 43.3% retail share. Cigar volumes improved 2.6% while the other premium category was down 7.1%.
Volumes for smokeless products declined 3.6% against an estimate of down 2.4%. Despite this drop in volumes, revenues net of excise taxes improved 4.6%. Copenhagen and Skoal combined for a 3.5% decline in volumes, although Copenhagen’s retail share did improve 0.3% to 34.6%.
Altria repurchased $195 million worth of shares during the quarter, completing the company’s previous $2 billion share repurchase authorization. The company announced that it expects to repurchase an additional $1 billion, or 1.1% of the current market cap, by the end of 2020.
The company expects the domestic cigarette industry to decline between 5% to 6%. Altria expects EPS of $4.15 to $4.27 for 2019. At the midpoint, this would be a 5.5% increase from the previous year.
Altria has compounded EPS at an annual rate of 8.5% over the last decade. Due to volume declines in the industry, we expect that the company will grow EPS at 4% per year through 2024.
Altria has increased its dividend 53 times in the past 49 years. The company’s dividend was reduced in 2009, but that was due to the spinoff of Philip Morris. The company has increased its dividend every year since, qualifying it as a Dividend Achiever, a group of stocks with at least 10 consecutive years of dividend growth. You can see all 260+ Dividend Achievers here.
Altria has increased its dividend:
- By a CAGR of 8.5% over the last three years
- By a CAGR of 7.6% over the last five years.
- By a CAGR of 8.6% over the last 10 years.
Altria increased its dividend twice in 2018, first by 6.1% for the 4/10/2018 payment and then by 14.3% for the 10/10/2019 payment. The next raise should be sometime in late August if the company sticks to its historical increase pattern.
Altria currently offers a 6.8% dividend yield that is fairly well covered. Investors should receive at least $3.20 in dividends per share this year. Using the company’s guidance for EPS, the dividend payout ratio is 76%. While this is an elevated payout ratio, it is below the stock’s 10-year average payout ratio of 81%. Altria aims to payout 80% of EPS in dividends.
Many investors prefer to use free cash flow to measure the safety of a company’s dividend. Altria had a one-time $1.8 billion charge related to higher payments of settlement charges in the second quarter that greatly reduced the company’s cash flow. This meant that dividends were not covered in the most recent quarter.
The company’s dividend appears much safer when using the long term view of free cash flow. The tobacco industry doesn’t require large capital expenditures so much of Altria’s cash from operating activities translates to free cash flow.
Including the one-time charge in the second quarter, the company produced $6.7 billion of free cash flow over the last 12 months. During that same period of time, Altria paid out $5.8 billion in dividends for a payout ratio of 87%. Excluding this one-time charge, the payout ratio falls to 69%.
Using EPS and the longer term view of free cash flow, Altria’s dividend appears very safe.
Valuation and Total Returns
Shares of Altria closed the 8/1/2019 trading session at $47.88. Using expected EPS of $4.21 for the year, the stock has a current P/E ratio of 11.4. The stock has traded with an average P/E ratio of 16.2 over the last 10 years. We have a 2024 P/E target of 15 given the declines in cigarette volumes. If the stock were to reach this multiple by 2024, then valuation would add 5.6% to annual returns.
Total returns would consist of the following:
- 4% EPS growth
- 8% dividend yield
- 6% multiple expansion
We expect that Altria can offer a total annual return of 16.4% through 2024.
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Marijuana legislation has become more popular in recent years, with many states approving the substance for medical purposes. While not yet legal at the federal level, several states have already decriminalized recreational use of marijuana.
For an investor looking for exposure to the marijuana industry as well as dividend income, Altria is a good option. The company has a large stake in Cronos and offers a yield of almost 7%. The company’s dividend is covered both by earnings and the last 12 months of free cash flow.
With a mid-double digit return potential, Altria receives a strong buy recommendation from Sure Dividend.