Why Altria Is up 10% This Year

Altria's shares have risen 10% this year to outperform the S&P 500, but can it continue?

Jul 7, 2014 at 12:57PM

The US' largest domestic tobacco company Altria (NYSE:MO) has put in an impressive performance this year. The company's shares have risen 9% during the past six months to outperform the wider S&P 500 by 2.2%. Including dividends, the company's shares have returned 11.5%. But what's the reason behind this strong performance, and will it continue?

Two reasons
Altria has outperformed this year for two reasons. Firstly, and most importantly, the wider tobacco sector has also put in a strong year-to-date performance; Altria has been dragged higher along with the sector.

Secondly, Altria has benefited from merger chatter as traders on Wall Street continue to speculate that a larger peer will buy out SABMiller (NASDAQOTH:SBMRY), of which Altria owns around 30%. A transaction of this size could net Altria more than $40 billion.

Additionally, Altria's shares have benefited from speculation that the company's management could be considering a large share buyback.

Sector performance
As mentioned above, Altria's performance this year has been helped by a rally in both the wider market and the tobacco sector. Indeed, year to date both Reynolds American (NYSE:RAI) and Lorillard (NYSE:LO), Altria's domestic peers, have seen their shares rise in excess of 20%, excluding dividends.

For the most part, these gains have been driven by bid chatter as Reynolds has revealed that it is in the process of acquiring Lorillard. You can find A One-stop Guide to the Potential Reynolds American-Lorillard Merger here.

Nevertheless, this chatter has driven sector valuations to record highs and this has benefited Altria. In particular, Reynolds, Lorillard, and Altria now trade at historic P/E ratios of 21.3, 19.5, and 19.2, respectively -- compared to five-year averages of 16.4, 14, and 15.2 -- according to data supplied by Morningstar.

What's more, dividend yields in the sector have also dropped. During the past five years Altria, Reynolds, and Lorillard offered an average yield of 5.5%. Now, the average yield is closer to 4.4%.

Unfortunately, the data above may indicate the overvaluation of the tobacco sector at current levels.

Still, Altria's performance this year has also been given a boost by SABMiller bid chatter.

Altria, as mentioned above, owns around 30% of SAB and this has become a valuable asset for the company over the past few years.

Indeed, SAB now contributes around $1 billion per annum to Altria's bottom line. Further, based on the current price of SAB, which has its primary listing in London, this holding is worth £14.1 billion, or $23.6 billion based on current exchange rates.

SAB has been the target of takeover speculation for some time and traders believe that a deal is imminent. The company's suitor can be none other than larger peer Anheuser-Busch InBev due to the size of the deal.

Wall Street believes that AB InBev would have to offer a 40% premium for SAB's shares, or around $134 billion at current prices. With 30% of this, or $40 billion, going to Altria shareholders could be set for one hefty special dividend.

And finally, Altria's shares have been given a boost this year as management has implied that the company could be considering a market moving share-buyback program.

This speculation was brought about by management's comments on the first-quarter earnings conference call.

When questioned by analysts about the possibility of returning more cash to investors, Altria's management responded:

...our normal practice has been that most of the cash returned to shareholders come through our 80% dividend payout ratio but opportunistically we'll do some share repurchase. So additional share repurchase is sure to be a discussion topic here over the next several months...So, certainly use of cash for something, we'll be looking at over the next few months ...

That's great news for investors who are already profiting from the company's existing 4.6% dividend yield.

Foolish summary
So all in all, Altria's shares have put in a strong performance so far this year, although unfortunately this performance does not look like it's set to continue. Altria's shares have benefited significantly from merger talk this year, and as of yet, no deals have been announced. 

What's more, this merger chatter has driven valuations to five-year highs. This implies that Altria's shares will struggle to move higher during the second half.

Overall, Altria's year-to-date performance has been impressive but it is unlikely to continue.

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Rupert Hargreaves owns shares of Altria Group. The Motley Fool recommends Morningstar. 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.

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