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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.