Value Investors Should Take a Look at Altria's Hidden Value

Altria's holding in SABMiller is worth more than it appears and investors are seriously undervaluing the opportunity on offer here.

Feb 18, 2014 at 2:00PM

Altria (NYSE:MO) and SABMiller (NASDAQOTH:SBMRY) are both quality companies, if I could I would own both stocks. Well I say 'could', I can, but I choose not to because I believe there is more value to be had in Altria than SAB. Altria owns nearly 30% of SAB, as it turns out, and it is cheaper to acquire a share in SAB through Altria because of the way that Altria accounts for its holding in SAB.

The value on offer
SABMiller's primary listing is in London, where presently the company has a market capitalization of approximately GBP 45 billion, or $75 billion. Altria holds a 27.1% stake in SABMiller worth about $22.4 billion. Now, according to data supplied by the Financial Times, SABMiller currently trades at a trailing-12-month P/E of 22, what some might call expensive. Altria, in comparison, trades at an unadjusted trailing-12-month P/E of 16 -- relatively cheap .

The Financial Times also tells us that SABMiller earned GBP 1.28 per share on a trailing-12-month basis -- that's roughly $2.10. With 1.6 billion shares outstanding, we can estimate that through its stake in SABMiller, Altria earned $1 billion on a trailing-12-month basis, which is confirmed later.

However, Altria's share of SABMiller is booked on its balance sheet at only $6.5 billion, which indicates that you can buy SABMiller through Altria at a trailing-12-month P/E of only 6.5!

Why the low valuation?
Why does Altria understate its holding in SABMiller? Well, this understatement results from the generally accepted-accounting-principles, or GAAP, equity method of valuation. Specifically, Altria's stake in SABMiller is less than 50%, and the company only has three seats on SABMiller's 11-seat board, so Altria does not exercise control over SABMiller.

As a result, Altria cannot fully consolidate SABMiller onto its balance sheet, and neither is the company allowed to mark the stake up to its current value. So, Altria can only record the book value of its SABMiller holding on its balance sheet, and as I discussed above, this holding is actually worth much more than it first appears.

Is Altria going to dispose of the holding?
Is Altria likely to sell? No, I doubt it because the company's management has previously answered this question by stating that the tax on realized gains would mitigate much of the capital gain from the sale. Altria would sell its SAB share for a price far in excess of book value and as a result the company would have to pay 33% federal and 6% state taxes on the gain -- ouch.

On a fundamental level, aside from the issue of tax, it would make no sense for Altria's management to sell the holding. According to Altria's management, the SAB investment generated pre-tax income of approximately $1 billion for Altria during the full year of 2013. Based on Altria's initial $6.5 billion investment, that's an annualized return-on-investment of 15.4%. $1 billion is also around 13% of Altria's annual earnings-before-interest-and-tax, or EBIT, so the company would lose out drastically if it disposed of the beverage giant.

Nevertheless, a tax-efficient spin-off would be a possibility. This would allow Altria to avoid a hefty tax bill, investors would benefit by receiving SAB shares, and Altria would be able to keep a share of the spin-off.

With Altria's seriously undervalued holding of SAB on its balance sheet and around $1 billion in extra income a year hitting the company's bottom line from the investment, it would be reasonable to assume that the company trades at a premium to its domestic tobacco peers. This is not the case. Based on forward, or estimated 2014, figures Altria trades at a P/E of 12.8. In comparison, peers Reynolds American and Lorillard (NYSE:LO) trade at a forward P/E of 14.

Now, it is understandable that Lorillard would command a premium over Altria, as the volume of cigarettes being sold by Lorillard is still grinding higher. Meanwhile Altria's sales are declining. However there is a problem here. You see, the risk at issue here is the impending regulation of menthol-cigarette products. I recently covered the key facts of the menthol argument here. Let's not get caught up in the "will they or won't they" argument, the most important thing we need to know is that more than three-quarters of Lorillard's revenue comes from the sale of menthol cigarettes, which could be problematic if menthol regulation occurs.

If we think about things logically, it is not unrealistic to suggest that if the U.S. Food and Drug Administration moves against menthol cigarettes, Lorillard will not lose all of its sales overnight. The company is likely to lose some of its sales, but it is more than likely that smokers will switch from menthol to regular cigarettes and stay with Lorillard's Newport brand. Still, with this risk hanging over the company, I'm left wondering whether or not Lorillard actually deserves a valuation premium over Altria.

So all-in-all, it would appear that investors undervalue Altria's holding in SABMiller and indeed Altria as a whole. Not only is the SAB holding contributing significantly to Altria's bottom line but the holding is worth tens of billions of dollars and provides a double-digit return for Altria.

Dirty little secret
With its 5.5% dividend yield, Altria would make a great addition to any dividend portfolio and one of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.


Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information