Will Altria Continue to Rally in 2014?

With the sharp rise in Altria’s stock in 2013, it has outperformed other tobacco companies such as Reynolds American and Lorillard. Will 2014 bring more of the same?

Jan 5, 2014 at 8:00AM

The tobacco industry hasn't done well in recent years. But this didn't stop Altria Group (NYSE:MO) from having a great year, with a 24% gain in the stock market. Will the company's fourth-quarter financial report maintain the stock's rally? And how has the company performed compared to its leading competitors, Reynolds American (NYSE:RAI) and Lorillard (NYSE:LO)

2013 full-year outlook
In Altria's third-quarter earnings report, the company revised upward its forecast for annual diluted earnings per share from an average of $2.53 to an average of $2.59. Most of the growth was due to the company's win in the arbitration panel on Sept. 11, 2013. The decision in the panel allowed the company to receive credit for its future payments under the tobacco master-settlement agreement. The company projects its fourth-quarter earnings to settle at around $0.58 -- a 4.5% increase compared to the year-ago quarter.

In the first three quarters of 2013, the company's diluted EPS grew by nearly 34%, but its net sales remained flat. Therefore, the company improved its profitability but not by increasing sales. In terms of profitability and revenue growth, how is the company doing compared to its peers? 

In the first nine months of 2013, Reynolds American hasn't done any better, and its revenue declined slightly by 0.5%. Conversely, Lorillard's net sales rose by almost 6% during the period. So Altria is in the middle of the pack where revenue is concerned. Let's turn to growth in revenue. 

The chart below shows the profitability of Altria Group, Reynolds, and Lorillard in the past several quarters.

Altria Group And Mo Profitablity Jan

Data: Google Finance.

The chart above clearly shows that these tobacco companies' profitability slightly increased in the third quarter of 2013. Reynolds has led the way in this area with nearly a 37% profit margin.

Based on the above, Altria doesn't dominate the tobacco industry in terms of growth in sales or profitability. In both segments the company is in the middle of the pack. Looking forward, could the company improve these parameters? Let's check a couple of business segments that could improve Altria's financial situation. 

E-cigarette and other non-smoke products
One of the potential ways in which Altria could improve its sales is with e-cigarettes. Alas, the company came late to the game, and has yet to augment its market share. Currently, the leader of e-cigarette sales is Lorillard, with its subsidiary, Blu eCigs. Lorillard's electronic-cigarettes brand accounts for 49% of this market. Moreover, this brand accounted for nearly 30% of its growth in sales in the third quarter. It's still unclear if this market will develop into a big-business industry as the tobacco industry has. But electronic cigarettes could be the next big revenue generator for tobacco companies in the years to follow.

For now, Altria is slowly entering this market via its subsidiary Nu Mark and its MarkTen e-cigs brand. The company has introduced this brand in Indiana and Arizona during the second half of 2013. Altria's stronghold in the tobacco industry could allow the company to augment its stand in the electronic-cigarettes market in the coming quarters. 

Altria has increased its sales of non-smoking products such as Copenhagen and Skoal. These products' sales rose by 11% in the third quarter and by 7.2% in the first nine months of 2013. Even though they account for only 7% of the company's total sales, their steady growth could partly offset Altria's drop in sales from cigarettes. 

Besides the potential growth in sales, Altria's main advantage remains its high dividend payment.

High dividend yield
Altria recently raised its dividend to an annual payment of $1.92 in order to meet its high goal of an 80% payout ratio. Currently, the company's payout ratio is around 67%. Under the current dividend payment the annual yield is set at around 5.1%.

Altria isn't the only one with such a high yield. Reynolds offers a yearly dividend of $2.52 per share, which is also an annual yield of 5.1%. Lorillard's current annual dividend is set at $2.20 per share, which comes to an annual yield of 4.4%.

The high dividend payments are also reflected in these companies' high payout ratios, which are around 70%, as indicated in the table below. 

Tobacco Lor Jan

Data: Google Finance.

Considering Altria's high dividend payment, and its performance in the stock market, let's examine if its valuation is still a bargain. 

Due to the sharp rise in Altria's stock price during 2013, the company's valuation has sharply increased. The table below shows the enterprise value-to-earnings before interest, taxes, depreciation, and amortization of the above-mentioned tobacco companies, and the tobacco-market average. 

Tobacco Lor Jan

Data: Yahoo! Finance and Damodaran's site.

As you can see, Altria is leading the way with the highest EV-to-EBITDA ratio of the three companies, at 11.1. This ratio is also much higher than the industry average. Conversely, Lorillard's and Reynolds' valuations are much closer to each other and the industry average. These numbers suggest Altria's valuation might be a bit high.  

Foolish takeaway
Altria continues to show great potential and still has several relative advantages over its competitors, including its dominance in cigarette market share, high dividend yield, and diversification with other assets. Nonetheless, other tobacco companies have relative advantages over Altria in terms of revenue growth, dominance in the e-cigarette industry, profit margins, and valuations. These factors suggest that Altria's current valuation might be too high and that other tobacco companies might have room to grow. 

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