Today's Buy Opportunity: Altria

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Today, my 11 O'Clock Stock is sin purveyor Altria (NYSE: MO  ) -- the company behind Marlboro cigarettes, Copenhagen and Skoal smokeless tobacco, and quarter-owner of the beer behemoth SAB Miller. Altria's not for every investor for a variety of reasons detailed below, but let's first look at a quick overview of the company:

Fast facts on Altria:

Market Capitalization

$46.2 billion

Industry

Tobacco

Revenue (TTM)

$16.7 billion

Earnings (TTM)

$3.5 billion

Source: Capital IQ, a division of Standard & Poor's. TTM is trailing 12 months.

I'm going to do something a little unorthodox today, by giving you 10 reasons NOT to buy Altria, in no particular order. Then I'll tell you why I still made Altria today's "11 O'Clock Stock" pick.

You shouldn't buy Altria because...

  1. It's a sin stock -- you may have moral qualms.
  2. At around 90% of sales, cigarettes are Altria's major product -- and cigarette volume in the U.S. is declining by about 3%-4% a year as health-consciousness and smoking bans decrease demand.
  3. It's highly leveraged, with a debt/equity ratio above 2.5:1.
  4. The interest rate Altria pays on that debt is quite high, because it took on onerous terms (near-10% interest rates on a ton of debt) to acquire smokeless tobacco producer UST (parent of Copenhagen and Skoal) in early 2009.
  5. The company's litigation risk will likely never go away.
  6. Altria spun off its international cigarette business as Philip Morris International (NYSE: PM  ) , leaving it fully exposed to the declining, litigious U.S. market.
  7. Excise taxes are hefty and a good way for governments to make money easily. Expect them to continue rising.
  8. Smoking bans are ever-increasing.
  9. The FDA tightly regulates the cigarette market.
  10. When you're at the top of your industry, there's only one way to go, right?

And it gets worse...

I'd shudder in terror at most companies that hold such high levels of debt AND commit to paying a 6.3% dividend yield. Between interest payments and dividends, that's a lot of regular cash commitments outside the utilities sector. Even looking at utilities, Duke Energy (NYSE: DUK  ) and Exelon (NYSE: EXC  ) are less leveraged (78%-94% debt-to-equity) and have lower dividend yields (5.7% and 5.1%, respectively) than Altria.

The redemption
But know this: Altria's No. 1 product isn't cigarettes ... it's cash flow. It's an absolute cash flow machine, pumping out the green stuff plentifully and steadily.

It generates huge cash flows (in absolute terms and as a percentage of sales) because its brands dominate the U.S. tobacco industry and it has immense pricing power.

Take a look at Altria's market share:

Source: Morningstar.

Source: Morningstar.

Reynolds American (NYSE: RAI  ) (Camel, Winston, etc.) and Lorillard (NYSE: LO  ) (Newport, Kent) are major players, but Altria's Marlboro brand is dominant with a 42% market share by itself.

As an industry, tobacco companies in general have pricing power; Econ 101 professors use cigarettes as their go-to example of inelastic demand. For those who slept through class, inelastic demand pretty much just means pricing power. So cigarette companies can raise prices to more than offset decreasing cigarette volumes. And Marlboro's the best brand in the business.

Let me show you another picture to illustrate how much pricing power Marlboro has:

Source: Altria.

Source: Altria.

Translation: Consumers are willing to pay 34% more for a pack of Marlboros than the cheapest alternative.

The bottom line
Altria has a lot of risks (like increased levels of litigation, excise taxes, and regulation), but they're known risks. Although it's hard to quantify those risks, at least we know to include them in our analysis. Think of the damage done to the stock prices of BP (NYSE: BP  ) and Toyota recently as examples of risks that no one saw coming.

I believe Altria's dividend stream, its brand dominance, and its pricing power make it an excellent addition to a balanced portfolio. For folks looking to add a new position, Altria is reasonable at current prices (around $22 a share), attractive below $20 a share, and a great deal below $18 a share.

 Previous recommendations

Come back to Fool.com on Monday for another great stock pick. There's plenty more great stock advice, and you can find video of each day's recommendation as well! To see the performance of previous recommendations, click here.

"11 O'Clock Stock" is sponsored by Motley Fool Stock Advisor. The Motley Fool will wait at least 24 hours after this publication before purchasing shares of Altria. To see an FAQ on "11 O'Clock Stock," click here.

Anand Chokkavelu owns shares of Altria and Philip Morris International. Exelon is a Motley Fool Inside Value pick. Philip Morris International is a Motley Fool Global Gains recommendation. Duke Energy is a Motley Fool Income Investor selection. The Motley Fool has a disclosure policy.


Read/Post Comments (21) | Recommend This Article (56)

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 August 02, 2010, at 11:15 AM, prime22 wrote:

    Not! At my age one tries to live the remainder of one's life without doing evil. I can't find a justification for tobacco. As far as I can see, the purpose of this product is to kill both the user, and those exposed to second hand smoke.

    Thanks for this new program. And, I have already made some money.

  • Report this Comment On August 02, 2010, at 11:34 AM, TMFBomb wrote:

    If anyone has questions or wants to discuss, hit me up here in the comments section!

    @prime22,

    Agreed that due to the nature of their products, Altria isn't for everyone.

    -Anand

  • Report this Comment On August 02, 2010, at 12:18 PM, revrurik wrote:

    There's a big difference between purchasing a 'sin industry' product and making money off of other people's 'sins.' I used to have a problem investing in companies like this, but the only person I'm hurting is myself by not investing in something that's going to allow me to make money, live better, and shop with vendors who match my own organic/natural/non-sin interests.

  • Report this Comment On August 02, 2010, at 12:41 PM, shivy1 wrote:

    Sin??? If thats the case then you should not invest at all. Almost every company has done something unethical at a point. The people to blame are the smokers, not Altria. The entire back part of cigarrete pack states the dangers of smoking, yet people continue to smoke. I know I may be criticized for this, but Altria is doing nothing wrong. They are not putting a gun to youre head and forcing you to smoke. Don't blame Altria for cigarretes, blame smokers. Also I would like to point out that MO has a strong brand presence oversees and continues to grow in areas where regulations are less stringent such as China and India.

  • Report this Comment On August 02, 2010, at 1:13 PM, flowmotion wrote:

    Well MO is certainly not for me.

  • Report this Comment On August 02, 2010, at 2:20 PM, TMFBomb wrote:

    @shivy1,

    To be precise Marlboro has a strong presence overseas...Altria handles the U.S. sales while its sister company Philip Morris International handles sales overseas.

    If the international element is what you're after, Philip Morris International is the play there.

    -Anand

  • Report this Comment On August 02, 2010, at 2:59 PM, valari25 wrote:

    People are making the informed decision to smoke, I am making the informed decision to invest in MO and make money.

    The only question I have is this:

    What does the author think is the tipping point? Cigarettes are inelastic but not perfectly so, at some point demand will really fall off. I don't much care about the lawsuits or the excise taxes, I worry about that price point that demand falls off a cliff.

  • Report this Comment On August 02, 2010, at 3:21 PM, TMFBomb wrote:

    @valari25,

    Thanks for the question. In the past, the cigarette manufacturers have been able to raise prices to more than offset volume declines. As they continue to do so, one threat is that taxes make up an increasing chunk of that. Consumers don't care who benefits from the price hike...just that they have to pay it (think of gasoline...you likely don't make the distinction between how much of the price at the pump is due to taxes vs. the price of oil).

    All that said, if there is a point at which prices can no longer be inelastically raised, Altria becomes (pun intended) a cigar butt type of company and we value it based on the remaining cash flows (and dividends) before death.

    If you believe Altria is a strong company otherwise and want to own shares, the best way to hedge against such a demand drop is waiting patiently for a good buy-in price. I stated in the article that I think anything below $18 is a great deal.

    -Anand

  • Report this Comment On August 02, 2010, at 4:31 PM, shivy1 wrote:

    Anand,

    Thanks for the clarification, I forgot Phillip Morris is part of MO technically, althought they are listed seperately .

  • Report this Comment On August 02, 2010, at 4:37 PM, shoemaker17 wrote:

    excellent stock pick. I think you should also talk about the tremendous cash flow this company generates...for the government. Secretly, they want people to smoke, so they can tax the hell out of them. oh, and cigarettes are delicious!

  • Report this Comment On August 02, 2010, at 4:59 PM, WyattJunker wrote:

    A sin stock? Really?

    Munis are sinful. Investing in T-bills is sinful. Luring private capital into public debt is sinful. And then there's the pitiful return for all that risk.

    Please.

    There's morals, and then there's MORALS.

    The government is the biggest sinner of all.

    Please, do not support them.

    Altria on the other hand, I have no problem with at all.

  • Report this Comment On August 02, 2010, at 5:07 PM, miclane05 wrote:

    I've done quite well actively seeking out unpopular stocks and this is certainly one of them do to the moral aspects. While I own MO in real life and believe its a strong investment, I do not think it should make up a large portion of a portfolio and would not buy at today's price (I'm averaged in at roughly $17.25 and would only consider adding more below $19.25).

    MO has not only weathered, but has trounced every storm it has faced, beginning with over 30 years of declining tobacco volume in the U.S. and including over a decade of work place, restaurant, and bar smoking bans, increases in taxes, and now FDA control. Looking at MO's chart relative to the S&P for any lengthy period illustrates the stock's ability to soundly overcome all of those headwinds.

    Eventually, however, this streak will end, and I am cautious of making this a major part of any portfolio. Today's price is too high to start a position, and future investors might want to wait for something below $19 or, better yet, for the FDA to make its decision regarding Menthol. If the FDA decides to ban the additive, as it is contemplating, the entire industry will see a quick drop in stock prices. MO, however, might actually benefit from such a ruling as it would increase market share by absorbing at least 50% of Lorillard's customer's who switch brands rather than quitting. If the FDA makes such a ruling, I might add some shares during the drop, and ride out the dividend for another 1-2 years before jumping ship in fear of further volume declines.

  • Report this Comment On August 02, 2010, at 5:29 PM, philkek wrote:

    Thanks MF for good article on this "sin" stock. You list good reasons NOT to buy. My main reason to buy MO years ago was to make money from the good dividend. MO plus 7 other MF advised holdings helped me double my money under 5 years. If you are after money this is one way to go. Better Business Bureau warns people to investigate BEFORE you invest. Fool on for profits.

  • Report this Comment On August 02, 2010, at 6:09 PM, plange01 wrote:

    altria is a top stock with a great dividend.the only bad part is that it is currently to high to buy.wait for this one to drop back to the $18- $19 this kind of stock trades in a tight range so this is a bigger drop in price than it may seem range.also keep a eye on all high dividend stocks due to the fact that the capital gains tax is scheduled to change at the end of the year at this point no one knows what affect this will have on these stocks....i just sold mo,pm,and kft

  • Report this Comment On August 02, 2010, at 7:22 PM, rookie2009 wrote:

    I'm also a biologist, along with being a retired autoworker. I smoke. 25 yrs ago I sat on my favorite dog's grave, and said..." There's nothing like a good smoke". Still true. Don't get me started on the weirdness of modern wealthy dog diets. They were basically beggars and scavengers till less than 100 yrs. ago. Now, I of course own MO because it's a stable moneymaker. I have unemployed family who'd buy Marlboros before taking care of their angels. But I repeat to all you Mensa whanabees... It's simple to sit back, collect, and hold MO as the best spec stock for it's potential. Reality....Uncle Sam will follow California and legalize pot. 5 yrs, 10 yrs, who cares. Still a great stock when it comes to making cash. Who owns the rights to the name Panama Red. I doubt if it's NROTPS. Jeez, can I apply for a job in the philosophy department....

  • Report this Comment On August 03, 2010, at 10:08 AM, bronzeguy wrote:

    I think the above is a good discussion, one which I haven't seen so far touching on the 'ethics' of investing.Sure smoking is a personal decision, but this company attempts to sell a known carcinogen to children. Don't we all have that scene in our memories of the 8 or 9 tobacco CEO's swearing that they didn't believe their product causes cancer? Do we need to throw ethics under the bus to make a few bucks? We all need to try to grow up and be responsible in so many ways. Sometimes focusing on simple stock stats obscures the real issues. thanks.

  • Report this Comment On August 03, 2010, at 10:42 AM, rnadkarni1 wrote:

    Sin or no sin! From a pure investing perspective, MO has been the best stock I have owned since 2004. It is not a stock that you get in and get out of quickly.

    I started buying it when it was hovering around $40. Then, somewhere down the road, Altria (around $22 today) spun off Phillip Morris (PM) (around $51 today) and Kraft (KFT) (around $29 Today). No a bad deal for sticking with it for 6 years. And do I need to mention the hefty dividends from all the three stocks that I have collected (and reinvested!) all these years.

    BTW - I have been investing in KFT and PM as well ever since they were spun off.

    I have now stopped tracking the gains from this stock as it almost always beats the overall market if you continue to reinvest the dividend steadily for long periods of time.

    What I don't feel good about is that I did not plunk all I had in 2004 into this stock. Because if I did, I would be closer to my dream of retiring a decade earlier and moving to some Caribbean or Pacific island paradise!

    Finally, this is a good stock to invest if you believe in dollar cost averaging over a longer horizon - continue buying at steady intervals with same $ amount - You buy more shares when the price is high and less when price is low and ensure that you reinvest the dividend - at least till the day that you really need the dividend in cash.

    BTW - I gave up smoking 14 years ago.

  • Report this Comment On August 05, 2010, at 2:46 PM, fridayeyes wrote:

    I own it. I will continue to own it. I will buy more whenever the valuation looks attractive. I will hold it indefinitely and pass it on to my heirs. I will buy it for the IRAs and Cloverdells of my children.

    Yup. That about covers it. :)

  • Report this Comment On August 06, 2010, at 2:33 PM, ikkyu2 wrote:

    Before anyone buys MO, a cigarette manufacturer retailing only to the US market, I'd suggest the following experiment:

    Hit up Google and find out what Warren Buffett, Bill Gates, and Mike Bloomberg are saying about cigarettes and tobacco.

    Then take a look at the Gates' Foundation position on domestic tobacco use. This charitable foundation has received more than $100 BILLION to support its works - that's more than Altria's market cap.

    I'm not saying that the Gates Foundation can put MO out of business. On the other hand, if you were going to start a business tomorrow, and Warren Buffett, Bill Gates, and Mike Bloomberg got on national TV and promised to use all of their wealth and all of their power to try to put you out of business, in the name of doing good for humanity - would it give you a little pause?

    Think about it.

  • Report this Comment On August 06, 2010, at 3:05 PM, lemoneater wrote:

    That's interesting, ikkyu2, three influential billionaires wanting a company to fail.

    I have my own reasons for not liking tobacco. Besides its long term health risks, I have trouble breathing if there is too much second hand smoke in my environment.

  • Report this Comment On August 07, 2010, at 7:12 PM, RaptorD2 wrote:

    I'm disappointed in your pick, Bomb, but only because I bought a few weeks and 7% ago. As far as the sin thing, if people want to use MO's products, it's their choice. Kind of like lotteries, which I consider to be voluntary taxes. Let 'em pay and I'll take their money. Lots of it.

    Great minds think alike (or if things don't work out, get bombed at the same time.)

    Dan

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