What's more appealing to an income investor than a stock with a high dividend yield? It's probably a stock with a reputation for growing its dividend. And what's better than a stock with a growing dividend? Many yield-focused investors would tell you it's a stock with a growing high-yield dividend that has attained Dividend King status.
Dividend Kings are S&P 500 stocks that have raised their dividend payouts annually for at least 50 consecutive years. A stock that qualifies has managed to generate excess income through all sorts of macroeconomic environments, including multiple recessions, bear markets, high inflation rates, and even stagflation. Dividend Kings have earned a reputation for stable and growing income over time and are sought-after investment options.
The tobacco company Altria Group (MO 0.76%) has earned this distinction. But it's also earned some ill will for the now controversial products that it makes and sells. Should income investors buy the stock? Let's drill down into its fundamentals and valuation and see if we can find an answer.
Huge share buybacks drove earnings higher
On July 28, the owner of America's best-selling cigarette brand, Marlboro, shared its financial results for the second quarter.
Altria Group reported $5.4 billion in net revenue in the second quarter, which was down 4.3% over the year-ago period. However, this decline is worse than it looks because it doesn't consider the sale of the company's wine business, Ste. Michelle Wine Estates, last October. Adjusting for this event, Altria Group's net revenue fell just 1.4% year over year. The company's net revenue declined because of a 10.9% drop in smokable segment volumes to 22.9 billion for the quarter. This includes Marlboro cigarettes and Black and Mild cigars. Thanks to its retail share of 48.2% of the U.S. market, Altria Group was able to mostly offset this volume drop with pricing increases. The segment's net revenue dipped just 0.7% year over year to $4.7 billion in the second quarter. The only reason that revenue didn't slightly increase for the segment was the inflationary pressures on consumers' disposable income.
In the oral tobacco products segment, net revenue decreased by 3.8% year over year to $633 million. Volume declines in premium brands Copenhagen and Skoal weren't able to be offset by gains in the oral nicotine pouch called on!, which is how the segment's volume dropped 4.4% year over year to 208 million cans and packs. Price hikes were only able to partially neutralize the drop in volume.
Altria Group recorded $1.26 in non-GAAP (adjusted) diluted earnings per share (EPS) in the second quarter, which equates to a 2.4% growth rate over the year-ago period. A 0.2% decline in net earnings to $2.3 billion during the quarter was more than canceled out by a 2.2% reduction in its outstanding share count to 1.8 billion.
As inflation eventually eases and consumers again have more disposable income, Altria Group should return to marginal revenue growth. Combined with share buybacks that it has the capital to execute, this explains the 4.3% annual adjusted diluted EPS forecast of analysts for the next five years.
Image source: Getty Images.
A sizzling dividend with room for growth
Altria Group boasts a 7.9% dividend yield, which is more than five times the S&P 500 index's 1.5% yield. Yet the dividend is very sustainable.
This is supported by the fact that Altria Group's dividend payout ratio is poised to be around 75% in 2022. For context, this is moderately lower than the company's target payout ratio of 80%. This gives Altria Group plenty of capital to repurchase shares, complete acquisitions, and repay debt.
The stock is significantly undervalued
Altria Group is a quality business. And it appears as though the stock is being overlooked by the market.
In fact, Altria Group's forward price-to-earnings (P/E) ratio of 9.4 is well below the tobacco industry average forward P/E ratio of 13.2. To be clear, the market has reason to be concerned about the company's future.
The relationship between Philip Morris International and Altria Group, in which the latter distributes the heat-not-burn tobacco product IQOS in the U.S., is in jeopardy. This would be one less growth avenue for the company. But its 10% stake in Anheuser-Busch InBev worth more than $10 billion should provide Altria Group with options to remain relevant for many more years. That's what makes the Dividend King a great buy for income investors.
