Is Altria Blowing Smoke?

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The United States' most dominant cigarette company reported second-quarter results earlier this week that did little to ease investors' worries amid increasing legislation and anti-smoking campaigns.

Altria (NYSE: MO  ) , most famous for its Marlboro brand that still commands 42.6% of U.S. cigarette share, went up in smoke following its earnings report. Overall profits fell 58%, mostly because of charges related to lease transactions, but plenty of other warning signs littered its earnings report as well.

Altria was able to reaffirm its full-year forecast of $2.01-$2.07 in adjusted earnings, but it cautioned that high unemployment rates and a weak economic environment are likely to affect consumer cigarette-buying habits.

The potentially damaging impact that new warning labels will have on U.S. cigarette manufacturers has investors worried, too. Based on an FDA ruling, Altria, along with U.S. rivals Lorillard (NYSE: LO  ) , Reynolds American (NYSE: RAI  ) , and Vector Group (NYSE: VGR  ) , will have to devote 50% of their packaging to warning labels describing the dangers of smoking by October 2012. In addition, company advertisements will need to devote at least 20% of space to these warning labels. Philip Morris International (NYSE: PM  ) has successfully integrated these challenges around the globe, but there's no telling what devastating effect this could have on U.S. tobacco companies.

Growth in the company's alternative to traditional tobacco products, smokeless tobacco, slowed to a crawl in the second quarter, with sales up only 4%. Altria still commands the lion's share of the U.S. smokeless-tobacco business, but the door is being left open for Reynolds American to close the gap. Smokeless tobacco makes up just a fraction of these tobacco giants' current revenue streams, but it could be the difference between bridging the gap if anti-smoking regulations continue to be adopted or falling by the wayside.

Even Altria's ability to pass along price increases to consumers can't be seen as a complete victory. It's clear that consumers are hooked enough on Altria's products to pay a premium price, but Altria's seasonally adjusted cigarette volume fell by 4.5%, worse than its previous guidance. The drop is predominantly due to the existence of cheaper alternatives in the form of Pall Mall from Reynolds American and Maverick from Lorillard. The company also sees shipping volume falling even further in the second half of 2011.

Make no mistake: Altria is a portfolio staple among dividend-seeking investors. It's very hard to argue against a company that, as fellow Fool Morgan Housel pointed out just last week, has returned a jaw-dropping 278,000% since the late 1960s if you had held your position and reinvested the dividends. And Fool Matt Koppenheffer has a more upbeat take on the company's future.  Altria's current yield is near the top of its sector at 5.6%, but it has its own set of worries -- namely, that it bears a significantly higher debt load than many of its peers and boasts a payout ratio of 76%, which could curb near-term dividend growth.

But yesterday's quarterly report only convinced me further that Altria's business model is broken. Even at 12 times forward earnings, the company isn't priced attractively enough in my opinion to attract long-term investors, considering the legal ramifications, anti-smoking campaigns, and intense competition surrounding this company. This company's best days may be behind it.

Is Altria on your buy list? Tell us in the comments section below, and consider adding Altria to your watchlist to keep up on the latest in the tobacco sector.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong  The Motley Fool owns shares of Altria and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International and writing puts in Lorillard. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's never the butt of any jokes.

Read/Post Comments (7) | Recommend This Article (11)

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 July 22, 2011, at 10:23 PM, edwardjf9 wrote:

    I have all of my money, every last dollar, on Vector Group, VGR.

  • Report this Comment On July 23, 2011, at 12:14 PM, lferrarese wrote:

    For more than 20 years analyst have been saying that thier best days are behind them and every time this is said they outperform. they have the best management in the business the best brands and and addictive product. I am a buyer

  • Report this Comment On July 23, 2011, at 4:54 PM, omni7 wrote:

    In one article MF tells me to buy MO, in the next, like this one, they suggest I sell. I've held it for ten years so far, lived through numerous litigations, spin-offs, and chicken little articles like this one. The sky is not falling MF readers. Short term earnings aside, the 2010 Altria annual report says that all sectors of the company were up, except the Capital Corp, the apparent source of the charge mentioned in this article. Here are a few other points:

    Yes Altria has debt. They should, they bought UST in 2009 I believe, for about $10B.

    Absent from this article, MO owns almost 30% of SAB MIller. This should be worth about $10B today, probably more.

    I take a longer term approach, and Altria has rewarded me for not only this attitude but my contrarian approach. This is a great company that finds a way to win and has navigated a tough anti-smoking environment for some time. I have hopes for their wine business as well, a pleasant surprise in the purchase of UST. I have no doubt that they will seek to diversify further. MO is not for everyone, but I have confidence in their future, their management, and their employees to continue to deliver. I suggest that everyone interested in any company do their own research, annual reports give great information and are often available for download, as I did with the MO report.

    I am long MO and will accumulate on significant price dips, while reinvesting dividends.

  • Report this Comment On July 23, 2011, at 4:55 PM, longertime01 wrote:

    If Warren Buffett has the patience to wait 10 years for KO to turn around, I will at least give MO a quarter or two.

  • Report this Comment On July 23, 2011, at 5:13 PM, longertime01 wrote:

    Marlboro brand volumn has increased 1% in this quarter! A pleasant surprise.

  • Report this Comment On July 25, 2011, at 1:02 PM, financeguy85 wrote:

    Nothing I can say that previous commenters haven't said. If your decision to invest or not invest in MO was dictated by the threat of litigation, regulation, and declining smoking rates, you wouldn't have put a dime into the stock at any point over the last 40 years, and you'd have lost out on a ton of money.

  • Report this Comment On August 17, 2011, at 4:26 AM, donnadon wrote:

    Marlboro is my favorite smoking brand

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