Altria (ticker: MO) is one of the biggest tobacco companies in the world. Altria has recently expanded its presence in two growth markets – e-cigarettes and marijuana – through two deals with JUUL Labs (privately held) and with Canadian marijuana company Cronos (ticker: CRON).
Altria offers reliable dividend growth, a high yield, shares trade at a relatively low valuation, and we believe that Altria is a good way for more conservative investors to get exposure to the marijuana industry.
Altria was founded in 1919 and is headquartered in Richmond, VA. The company is currently trading with a market capitalization of $92 billion. Its main business is its smokeable tobacco business (cigarettes and cigars), but the company also operates a smaller non-smokeable tobacco business and a wine business. On top of that Altria holds a ~10% stake in Anheuser-Busch InBev (ticker: BUD), which is one of the largest beer companies in the world.
Altria reported its most recent quarterly results on October 25. The company grossed revenues of $5.3 billion during Q3, which represents an increase of 3.3% year over year. Altria was able to grow its earnings-per-share by 20% year over year, to $1.08. Tax rate changes had a major impact, though, operating earnings growth does not support earnings-per-share growth rates that are this high, which is why investors should not count on 20%+ growth rates going forward. Altria guides for earnings-per-share of $3.95 to $4.03 for fiscal 2018, and management has stated that they will grow their earnings-per-share by slightly less than the long-term target of 7% – 9% during fiscal 2019, so probably by 5% – 6%.
The tobacco industry is highly profitable, even though smoking rates in the US (the only market where Altria sells its cigarettes) keep declining. In the past Altria and other tobacco companies were able to offset the declining volumes by increasing the price per package at a meaningful pace every year. Since the price increases were larger than the volume declines, industry revenues kept increasing. Cigarettes are a product with very inelastic demand, which means that consumers do not react to price increases very much. This will likely rkemain the case going forward, which means that Altria should be able to increase the price per cigarette that it sells in the future as well, which provides a solid growth outlook for its core business. Traditional tobacco will never be a high-growth industry, though.
Altria has entered two high-growth industries through two large deals that were announced in December, the e-cigarette industry and the marijuana industry. Altria agreed to acquire a 35% stake in privately held JUUL Labs for $12.8 billion. JUUL Labs, which sells the Juul e-cigarette, is the dominant market leader in this fast-growing market. The company’s product is especially popular among younger adults, which gives Altria access to consumers that could turn into highly valuable long-term customers.
Altria has also agreed to acquire a 45% stake in Canadian marijuana company Cronos, at a price tag of $1.8 billion. Altria has an option to acquire an additional 10% of Cronos for an additional $470 million. The stake in Cronos gives Altria exposure to the emerging marijuana industry, which consists of the medical marijuana as well as of the recreational marijuana markets.
Cronos is active in its main market Canada (the largest market for recreational marijuana), and in several other countries, including the US, Germany, Israel, and Australia on top of that. So far Cronos is not profitable, but the recreational use of marijuana in Canada has only been legalized in October, thus sales to this huge market are not reflected in past results yet. It is likely that Cronos’ upcoming quarterly results will be significantly stronger than what the company has reported so far. This acquisition gives Altria exposure to the fast-growing marijuana market, while at the same time Altria only risks the $1.8 billion that it invested. In case marijuana ever gets legalized in the US on a federal level, Altria would benefit from its experience and would likely be able to scale its marijuana business fast to capitalize on this opportunity.
The $14.6 billion that Altria spent on these two acquisitions are not a small price tag, and the additional interest expenses will negatively impact Altria in the short term, which is why Altria guides for a somewhat slower earnings-per-share growth during fiscal 2019. Altria has announced a new cost-cutting program, though, which will balance this out in the longer term. On top of that, growth from both JUUL Labs and Cronos could meaningfully enhance Altria’s profits over the coming years.
Valuation, Dividends, And Expected Returns
Altria’s shares trade at $49 right now, which is the lowest share price since mid-2015. The sell-off in the broad equity markets, combined with pressure on dividend stocks (due to rising interest rates, which means that some income-oriented investors switch to bonds) has made Altria’s shares decline significantly over the last couple of months. Based on the company’s forecasts for earnings-per-share of ~$4.00 in 2018 and ~$4.20 in 2019 shares are valued at a very inexpensive valuation of just 12.3 times this year’s earnings and an even lower 11.7 times next year’s earnings.
The share price decline, coupled with two dividend increases during fiscal 2018, has made Altria’s dividend yield rise to levels not seen for several years. Shares offer a dividend yield of 6.6% right here, which is roughly three times as much as the broad market’s yield. Altria pays out roughly 80% of its earnings in the form of dividends, but as its profits are very reliable and as they were not impacted by recessions in the past, the dividend looks safe despite the rather high payout ratio, we believe.
Through a combination of its high dividend yield and some earnings-per-share growth Altria should easily be able to produce double-digit total returns going forward, even without any multiple expansion. When its valuation expands closer towards the historic range (which would mean a price to earnings ratio in the mid to high teens range), its share price gain potential would be even bigger.
Altria is a high-quality income stock that offers a high dividend yield, a low valuation, and reliable earnings and dividend growth. On top of that Altria gives investors exposure to the marijuana industry, as well as to the dominant market leader in the fast-growing e-cigarette industry, which should enhance Altria’s long-term earnings growth potential. Shares will offer attractive total returns going forward, we believe.