Through the first few months of 2022, all anyone has really been able to talk about is inflation and recession worries. Stocks have gotten hit fairly hard by these concerns, with the S&P 500 Index down approximately 10% year to date. The same can't be said for Altria Group (MO 0.12%), though. The cigarette maker and sin-stock conglomerate is up 19% this year as investors flock to defensive assets that tend to hold up well in a recession.
On the morning of April 28, Altria put out its first-quarter 2022 earnings, showing once again why the tobacco and nicotine business is so resilient to the economic cycle. Here's why the stock is up 19% this year.
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Q1 2022 results
In Q1, Altria's consolidated revenue declined 2.4% year over year (YOY) to $5.9 billion. Volume at Marlboro -- its No. 1 one product by a wide margin -- declined 5.8% YOY to 18.3 million sticks. These numbers might make you think this was a bad quarter for Altria. But this has been part of the playbook for Altria over the last few decades. Even though volumes declined in Q1, operating income in the smokeable products segment (which houses Marlboro) grew 7.9% YOY to $2.56 billion as operating margins expanded from 57.5% to 59.5%.
So, why does Altria and, more specifically, the tobacco business hold up with declining volumes and through poor periods of the economic cycle? A few reasons. First, and this is the harsh truth, people are addicted to cigarettes. We all know the harm these products can cause, and if that makes you uncomfortable buying the stock, I don't blame you. But it creates a steady stream of repeat customers.
Second, a scaled cigarette manufacturer like Altria requires minimal capital expenditures and material inputs relative to the size of the business, meaning it is insulated from many inflationary pressures. Third, the company has shown it can consistently raise prices, counteracting any volume declines and increasing operating margins. These three factors add up to an incredibly resilient business.
Growth of nicotine pouches + minority investments
Outside of smokeable products and cigarettes, Altria has a small but fast-growing nicotine pouches segment with its On! brand. Nicotine pouches are a cleaner, healthier way for people to get their nicotine fix and have been rising in popularity over the past few years. In Q1, On! shipment volume grew 99% YOY to 18.3 million packs. Retail market share also grew from 1.6% in 2021 to 4.1% this year, showing the great progress Altria is making with the product.
Altria has minority investments in other sin industries outside of its owned subsidiaries. These equity investments add up to $13.5 billion in estimated value at the end of the first quarter and include a 35% stake in the vaping company JUUL, a 10% stake in Anheuser Busch, and a 45% stake in cannabis company Cronos Group. By far, the most important of these equity stakes is Anheuser Busch, worth around $10 billion and generating consistent dividend income for Altria each year.
Balance sheet is a weak spot
The weakest spot of Altria's business is the balance sheet. The company has $2.5 billion in short-term debt and $25.4 billion in long-term debt, which gives management less flexibility with its cash flow. $6.4 billion in annual dividend payments also need to be fulfilled. With around $8 billion in annual operating cash flow, $5 billion in cash on the balance sheet, and an equity investment in Anheuser Busch that can be sold in a pinch, there are no bankruptcy concerns with Altria Group. But this isn't a conservative balance sheet by any means.
MO Cash from Operations (TTM) data by YCharts.
With that being said, you can't go wrong with Altria's dividend, even with the stock up almost 20% this year. At a 6.5% annual yield, forward returns can be solid even if the stock doesn't move. With the stock still trading at a cheap price-to-operating cash flow (P/OCF) of 12.5 and a new share repurchase program lowering shares outstanding, I think Altria's stock can be higher three to five years from now, especially if investors continue to want defensive stocks.
Investors need to watch out for balance sheet health in a rising-interest-rate environment, but that shouldn't deter you from investing in Altria. If you are comfortable owning a tobacco business, this stock can be a steady winner for your portfolio over the next decade.
