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Could Altria Group Be a Millionaire-Maker Stock?

By Rich Duprey - Oct 17, 2017 at 9:30AM

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The tobacco giant was knocked back by potentially restrictive new regulations, but its smoke-free future still looks bright.

Altria (MO 1.15%) sits just above its 52-week low, a surprise hit to its valuation caused by the Food & Drug Administration proposing regulations that could severely impact its bottom line. But the market is looking at that risk as if the threat was imminent, rather than being a long-term hurdle it will have to get over.

Because the cigarette giant still commands substantial market power, profit-generating leverage, and a number of unique opportunities for growth, Altria's new, lower price is an excellent spot for investors who want to be millionaires in the future to get in.

Cigarettes on $100 bills

Image source: Getty Images.

A non-addictive cigarette

What shook the tobacco company's stock from its moorings was an FDA proposal to require cigarettes to reduce the nicotine in them to levels where they wouldn't be addictive. Because that arguably might be a negligible amount and difficult to attain, it's a threat to Altria's very business.

Although fewer and fewer people are smoking, Altria and other cigarette makers are able to generate substantial profits and margins because those who do continue to smoke still pay up for the opportunity to do so. While that speaks to the addictive nature of cigarettes, it also means the industry can raise prices almost at will without losing customers. Sure, some people will always quit as the price rises, but enough remain to more than make up the difference.

Earlier this year as California prepared to hike excise taxes on tobacco products -- and for the first time products like electronic cigarettes that contain nicotine -- Altria beat them to the punch and raised the price on a pack of cigarettes by $0.08, a move that was quickly followed by other cigarette companies.

Typically Altria and the others raise prices twice a year, in May and November, or about every six months, but this time they moved earlier to beat the state's tax hike. By raising their own prices, the tobacco giants minimize the hit to their profits.

A lesson in inelasticity

So it was not a surprise that last month Altria again announced it was hiking prices again, but this time imposing a $0.10 per pack increase, a move that was again quickly followed by Reynolds-American and others. What was notable was that on a percentage basis, it was Altria's biggest hike since 2011.

Altria reported second-quarter earnings this summer that showed how effective this policy is. While revenues for the six-month period were up only 1.2%, operating income was up 9%, boosting operating margins to 37.5% from 34.9% last year.

Now that the market has had an opportunity to absorb the news of the potential regulatory threat, something that likely won't be in the picture frame for years, Altria's profit-making ways can take center stage once more.

A shops selling iQOS devices in Japan

Image source: Phillip Morris International.

Look forward, not backward

But it's not just cigarettes that make Altria a buy here. As Philip Morris International (PM 0.99%) has stated, the future is one that will be "smoke-free." The global tobacco company has developed and is pushing its "heat-not-burn" device, iQOS, that could revolutionize the industry. While there are similar ones on the market from Reynolds and its new owner British American Tobacco (NYSE: BTI), the iQOS looks to be leaping ahead in gaining market acceptance. Philip Morris has also applied to the FDA to garner a "reduced risk" classification that could give it significant competitive advantages.

That will benefit Altria because the device is being marketed under its Marlboro brand as "Heat Sticks," and the FDA's proposed new nicotine policy could drive more users to the device. Moreover, analysts believe it may also further the possibility Philip Morris will attempt to acquire Altria and rejoin the two businesses that were split apart in 2008.

In short, Altria's stock was knocked back to attractive levels over fears of a policy that probably won't impact it for some time, while it still possesses qualities that make its stock a buy right now. With potential catalysts such as heat-not-burn technology and a potential merger on the horizon, Altria could very well be a millionaire-maker stock for those getting in now.

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Stocks Mentioned

Altria Group, Inc. Stock Quote
Altria Group, Inc.
MO
$42.25 (1.15%) $0.48
Philip Morris International Inc. Stock Quote
Philip Morris International Inc.
PM
$99.72 (0.99%) $0.98
British American Tobacco p.l.c. Stock Quote
British American Tobacco p.l.c.
BTI
$43.28 (0.86%) $0.37

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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