Is Altria a Buy?

With a trailing price-to-earnings ratio of 12.2, a forward P/E of 10, and a dividend yield over 7%, Altria (NYSE: MO  ) shares could be one of the best buys in today's rocky and uncertain market.

But are they?

Putting aside Altria's litigation risk, the key question is whether future product price increases can offset what is likely to be a continually shrinking U.S. cigarette market. The cigarette business represents roughly 89% and 85% of Altria's total revenue and operating income, respectively. Recently, the answer's been mixed.

In 2008, cigarette volume contracted by 3.2%, while segment revenue net of excise taxes nonetheless rose 2.6%. During 2009, however, both metrics declined, with cigarette volume dropping 12.2% and segment revenue net of excise taxes sinking 6.2%.

As something of a counterpoint, bottom-line performance has been more consistent. Driven in large part by cost cuts, adjusted earnings per share from continuing operations gained 10% in 2008 and 6.1% in 2009. However, major efficiency gains will likely come to an end after 2011. After that, higher profits, and ostensibly, large dividend increases, will depend on how well customers swallow price increases.

On that note, Altria bulls like to remind doubters not to underestimate the pricing leverage provided by what is optimistically described as a captive consumer base. But I'd hesitate to extrapolate past pricing success. Premium brands account for about 93% of Altria's total cigarette volume, and that fact stands in stark contrast to stubbornly high unemployment and signs that the U.S. consumer is once again weakening.

Altria's jumbo-sized dividend is another point around which bulls rally. Indeed, that 7% yield easily bests the 4%-5% yields offered by other major consumer packaged goods companies, which include H.J. Heinz (NYSE: HNZ  ) , Kraft (NYSE: KFT  ) , and Altria's global tobacco spinoff Philip Morris International (NYSE: PM  ) . But if dividend income is the best argument you can make for a stock, why not upgrade your risk profile and go with a bond fund? Far afield from U.S. Treasuries, which may or may not be in a bubble, MFS Emerging Market Debt and Templeton Global Bond Fund, for example, have returned an annualized 12.7% and 10.8%, respectively, during the past 10 years.

If the market restricts its outlook on Altria to the next couple of years, during which time cost cuts will continue to juice the bottom line, investors could enjoy modest capital appreciation. For instance, during the past two and a half years, shares have traded at an average trailing P/E between 7 and 13. And if we enthusiastically put a 12 multiple on management's midpoint estimate of $1.87 in 2010 adjusted EPS, then we get a stock price of $22.44 -- a double-digit percentage gain from today's levels. Apply the same multiple to analysts' 2011 EPS estimate of $1.99, and our target price rises to nearly $24.

Does that make Altria shares a buy? If your timeline is the next 12-18 months, I'd say yes -- but reluctantly. After all, there's no guarantee that the market will agree that a 12 P/E is fair. That sort of multiple might be reserved for Reynolds American (NYSE: RAI  ) , which has a stronger foothold in the value segment.

Longer term, it once again comes down to your perspective on the price-volume dynamic. And given macro and industry uncertainties, it's difficult for me to see how a positive outlook could represent anything other than blind faith.

Philip Morris International is a Motley Fool Global Gains selection. H.J. Heinz is an Income Investor pick. Try any of our Foolish newsletters, free for 30 days.

Fool contributor Mike Pienciak owns shares of Templeton Global Bond Fund but holds no financial interest in any other company mentioned in this article. The Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 16, 2010, at 2:06 PM, plange01 wrote:

    when mo gets below $18 its a buy right now its still to high give it a few more weeks...

  • Report this Comment On June 16, 2010, at 2:28 PM, mikecart1 wrote:

    MO is the greatest buy today, tomorrow, yesterday, last year, last 10 years, next 10 years. People smoke. That is all you need to know.

  • Report this Comment On June 16, 2010, at 2:32 PM, kalvinkuhn wrote:

    Your article campares MO's dividend against the annualized return of a bond fund. If this wasn't a self serving comparison, shouldn't you campare MO's total return (dividend + capital appreciation) to the bond fund's annulized return?

    I think I am going to cancel my foolish subscription... It appears that there is little editorial oversight at the Fool these days.

  • Report this Comment On June 16, 2010, at 2:51 PM, lrm21 wrote:

    KalvinKuhn took the words out my mouth.

    Also, bond funds do not increase their dividend every year. which altria has been doing.

    Cigarette companies can no longer advertise, and as such all the counts going forward is what brand is most established. People smoke, and when they do what will they smoke?

  • Report this Comment On June 16, 2010, at 3:58 PM, bzhayes wrote:

    KK and Irm21,

    Perhaps you didn't read the sentence introducing the idea of comparing to a bond fund, "But if dividend income is the best argument you can make for a stock, why not upgrade your risk profile and go with a bond fund?" The author clearly states, that if you like MO only for its dividend and not for its continued growth, then a bond fund comparison is apt. Just because MO grew in the past doesn't mean it will in the future.... indeed that is the whole point of this article. Their is good reason to believe MO's run is done.

  • Report this Comment On June 16, 2010, at 4:30 PM, paulnovell wrote:

    Agree with KK and Irm21, what a terrible piece of analysis. To add to their a comments:

    The author spends some time analyzing the potential future returns of MO. Fine so far. MO may be a bad investment going forward. I don't think so but maybe. But then he throws in a comparison to two cherry picked bond funds and cites historical returns without any analysis of their future prospects and/or risks! Geez.

    Oh and by the way, the 10yr historical return of MO is 16.6% (according to Morningstar) handily trouncing those two bond funds.

    I've canceled most of my Foool subscriptions over the past 4 years. Now I think I'll cancel them all.

  • Report this Comment On June 16, 2010, at 6:17 PM, kalvinkuhn wrote:

    TMF Glide (aka Mike Pienciak) -

    The self serving comment was clearly written to make it easier for you to write the article. I would think that you would do your homework before you start to write. You stated that some claim that MO's dividend is the "best" argument to own the stock; however that is not anywhere near the complete argument (as your analysis against bond funds seems to indicate) and you should know that (perhaps not?).

    I am cancelling my subscription to Motley Fool Options (and before that a member of Rule Breakers and Hidden Gems). Perhaps you should check to see if someone is a customer before you decide to pick a fight in the schoolyard.

    Thanks for your concern.

  • Report this Comment On June 16, 2010, at 10:32 PM, xp308 wrote:

    I am a huge fan of MO. The dividend is great and there is some price appreciation too. My big concern is the upcoming decade-old racketeering lawsuit.

    Anyone else have thoughts on possible outcome of this pending case?

    http://www.google.com/hostednews/ap/article/ALeqM5iKinN7f7yE...

  • Report this Comment On June 16, 2010, at 10:38 PM, wrldtrvlr wrote:

    Yes, KK, I'm sure you're cancelling your account because of this article.

    Could it be because you research companies as well as you read this article and have lost a small pile of money?

    I'm not cancelling my subscriptions because I make money off of my stock picks.

    Best of luck, though.

    I own MO and PM.

  • Report this Comment On June 17, 2010, at 12:07 AM, TheDumbMoney wrote:

    Not sayin' MO is the greatest stock on earth.... But again, as with every Fool article before it that I have seen, this article completely misses the SABMiller story portion of MO. SABMiller is nearly 1/3-owned by MO as a result of the Miller sale, and is carried on MO's books at a substantial discount to the value of MO's actual holdings, if one looks at SABMiller's share price. MO's SABMiller holding alone should give it some shareprice growth, even if the cigarette market stagnates and even marginally declines. The P/E is higher than you think it should in some part because the Market knows about SABMiller. Why the Foolish ignorance/myopia?

  • Report this Comment On June 17, 2010, at 11:29 AM, financeguy85 wrote:

    I'd like to add the fact that Altria purchased UST in 2008 to give them a very strong position in the smokeless market, which is growing, as well as cigars and wine. Yes, cigarette volumes are declining, but they can buffer that well enough with cost cuts and price increases. Remember, smoking is addictive. People will smoke regardless of the economy. Since they distribute 85 percent of their earnings as dividends, you can count on them continuing to pay a huge yield with a moderate annual increase. The "death of tobacco" story has been repeated for decades. Not happening.

  • Report this Comment On June 17, 2010, at 12:49 PM, stan8331 wrote:

    I don't think MO is a bad stock, but I do think its past returns are not necessarily predictive of the future. There's a limit to how much any company can cut costs, and it is hard to see where you're going to get much growth in the US market.

    I prefer PM to MO - much better growth opportunities, the current dividend isn't exactly chopped liver, and it also provides a currency hedge for portfolios weighted toward US equities. It's down now on concerns about Europe, but tobacco is a pretty stable business to be in.

  • Report this Comment On June 17, 2010, at 3:07 PM, TheDumbMoney wrote:

    TMFGlide, all true.

    But given that the publicly traded value of MO's SABMiller stake has (if I'm not mistaken, and when last I checked) nearly tripled, since 2002, and given that MO, per its latest annual report, carries the stock at a huge, huge discount to that value, it's something the Fool is wrong not to at least mention (and repeatedly so). Don't you wish your investments had done that well since 202? I certainly do. Also, SABMiller has strong positions in Latin America, as well as in Africa, and is half owner of Snow Beer, which is the most popular beer in China, and which overtook Budweiser as the best-selling beer by volume, in 2008 or 2009, if I'm not mistaken. SABMiller also is strong in India. I'm sorry, with all due respect, it's nonsense not to at least mention SABMiller, even if you think it is discounted by your perception of the US cigarette story (which is also tempered, as other commenters have pointed out, by the UST story). Fundamentally I agree that the picture for cigarettes in the U.S. does not look good in the long-term, but governments get so much tax revenue from them, that they are likely never going to go away entirely. In the meantime, whether or not they work out, MO has other pots on the fire. Take care.

  • Report this Comment On June 23, 2010, at 1:47 PM, Puckplayr4 wrote:

    Wow...I read this article and thought, "What a really good article". It opened my eyes maybe a little, made me stop and think that something that I thought of as a given might not be. MIGHT not be...then I read the comments and thought "Damn, these people sure are passionate about this stock". I think Mr. Pienciak took a fair approach by replying to your comments...but from an outsiders perspective, if you are that emotional about a stock, sell it on principal. I almost DON'T own MO or PM because of an ethical objection, but thats not smart now, is it? Neither is loving a company regardless of reality. Or possible realities. Thats all this article is...a possible reality to consider. Damn...stop drinking the MO cool-aid people! Get over it! Any argument he made could be attacked. Anyone who owns a stock and doesn't want to see the train coming down the tracks should just stick their heads back in the sand and keep depositing your money into what might be a well. I have stopped buying Altria in favor of Phillip Morris International for the reasons Stan8331 mentioned above. The SABMiller argument is good to consider too...but isn't that what this forum is...a chance to openly discuss educated opinions? Thanks TMFGlide, appreciate the article and the new awareness of the bond funds!

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