Altria Group (MO -0.13%) has enjoyed strong performance in its stock price recently, hitting levels last month that it hadn't seen since before it spun off its international operations into a separate company. Despite Altria's rewards to its shareholders, the tobacco company faces some major challenges that could hurt its business in the long run and bring down its share price. In particular, the following issues have the most potential to have a negative impact on Altria going forward, and investors need to understand the risks involved.
1. Merger plans will strengthen Altria's main competitor.
Altria has long been the leader of the U.S. tobacco market, but Reynolds American (RAI) has made large advances in its competitive position. The buyout of Lorillard several years ago brought together the No. 2 and No. 3 players in domestic tobacco, leaving Reynolds a lot closer to Altria in terms of market share. In particular, the popularity of the Newport brand posed a true challenge to Marlboro once it had the full marketing power of Reynolds American behind it.
Now, British American Tobacco (BTI 0.21%) intends to take full control of Reynolds American, creating a global powerhouse that will be able to take a unified worldwide approach toward marketing both its traditional cigarette products and its newer alternative-products portfolios. Altria hasn't made any substantive comments about the Reynolds-BAT merger, insisting that it already has strategies in place to deal with competitors. Nevertheless, it will be important for Altria to consider measured responses once the merger goes through to make sure that British American doesn't jeopardize Altria's leadership in domestic tobacco.
2. Altria could get left behind in reduced-risk products.
Globally, the traditional cigarette market has been far weaker than the booming cigarette-alternative arena. Consumers have shifted their preferences toward electronic cigarettes and other innovative product lines, and global players like British American have made next-generation products a priority.
Altria hasn't fully embraced reduced-risk products to nearly the same extent as some of its peers. Its MarkTen and Green Smoke lines of products have shown reasonable amounts of success, but the company has failed to acknowledge that they might eventually need to take over the reins from its traditional cigarette lines. More encouraging is Altria's right to market the iQOS heated tobacco system in the U.S., and the Food and Drug Administration is considering an application for commercializing iQOS as a modified-risk tobacco product. Even here, though, Altria doesn't actually own iQOS, leaving it in a weaker position that shows its lack of resolve toward embracing innovative products.
3. Taxes and consumer attacks will likely increase.
Taxing authorities see tobacco as a honeypot for potential revenue, and Altria has suffered as key states consider tax increases. Last year's successful ballot measure in California dramatically increased tobacco taxes, and political commentators have predicted similar measures in other states going forward.
Altria can also expect to see ongoing pressure from consumer groups attacking its sales. One charge has pointed to practices among cigarette companies that target poor neighborhoods with advertising campaigns, with allegations of predatory intent. Ongoing efforts to reduce smoking will inevitably continue, but Altria also has to be careful that it doesn't hurt its reputation among its customer base by mishandling its responses to aggressive action from consumer advocates.
4. Rising interest rates could hurt valuations
Finally, Altria has benefited, in part, from the demand for high-yield dividend stocks. Altria has historically had much higher dividend yields that reflected the higher risk of the tobacco business, but lately, the stock's yield has fallen to just above 3%. That's higher than the market average, but it leaves Altria vulnerable to share-price declines if rates reverse course.
In particular, some investors only own Altria shares because alternatives like bonds and fixed-income investments don't pay enough interest. If rising rates make fixed-income investing viable for those investors again, they could sell their Altria stock. That would push share prices lower, boosting dividend yields to a new equilibrium, but leaving existing shareholders with losses.
Altria has plenty of promise, and things aren't all downbeat for the tobacco giant. Investors do need to know what they're getting into and the risks involved, By knowing about the key issues affecting Altria, you can make a better decision about whether to own its shares.