Altria Group (MO 1.91%), the largest U.S. tobacco company and owner of the Marlboro cigarette brand, has been raising the price of its product for decades to combat a smoking rate that's declined since the 1960s, when the Surgeon General first publicly declared cigarettes are harmful.
Smoking is still big business for Altria. Its smokable products accounted for $2.8 billion of its $3.1 billion operating income for its second quarter of 2022. Just how much longer Altria can offset its declining volumes with price increases is a fair question. Most investors own the stock for its dividend, which would face trouble if profits decline. Here is what investors need to know.
How resilient are cigarette prices around the world?
Cigarettes have proven to be relatively inelastic, meaning that increasing the price doesn't dramatically impact demand for the product. In other words, Altria keeps raising prices, and people keep buying cigarettes. Don't get me wrong, the company ships fewer cigarettes each year because of tobacco-related deaths, people quitting or reducing their smoking habit, and fewer people picking up smoking. Altria shipped 44 billion cigarettes through the first half of this year, down 8.8% from the first six months of last year.
But you can see the impact of pricing power, as operating profits keep climbing year after year:
MO Operating Income (TTM) data by YCharts
One might assume that there's an eventual breaking point where pricing can no longer compensate for the loss in volume, which is probably correct. The big question, though, is how long can Altria play this game? It might be longer than you would think.
According to data tracked by Numbeo, the average price of a 20-pack of Marlboro cigarettes in the United States is $8.79. That slots in as the 14th most expensive market in the world, despite the U.S. being one of the world's wealthiest countries.
Cigarettes are far more costly in other countries; take Australia, for example, which charges an average of $26.01 per pack, or the United Kingdom, which charges $13.65 per pack.
Years of price increases left?
Estimating how long it could last is difficult due to various factors. The smoking rate could decline faster or level off over time, and economic factors could also play a role. High inflation could hurt discretionary income and push smokers to cut back. Hypothetically, Altria could still have time to raise prices. The company could hike cigarette prices 5% annually and double prices to $17.58 per pack over 14 years.
A way to tell when price hikes lose effectiveness is to follow the company's operating income.
Operating profits have grown by an average of 5.3% annually over the past decade and 5.9% over the most recent three years. Operating profits are growing faster instead of slowing down, which seems to be a pretty strong signal that Altria isn't running out of metaphorical rope in its price hike game.
Suppose the company begins to see operating income stagnate. Or worse, decline. That could be a red flag that Altria's starting to dry up its pricing leverage with smokers.
Looking at things on a per-share basis
Ultimately, most people who own shares of Altria are in it for the dividend, which yields 9% at the current share price. Altria's business financials support the dividend, which means that maximizing per-share profits will be most important in growing the dividend.
Even if total operating profits eventually face pressure, Altria can slow the dividend's demise even further by using share repurchases to reduce the share count, which would, in turn, shrink the company's total dividend expense. Over the past year, management has spent about $2 billion on share repurchases. It also has a 10% stake in Anheuser-Busch worth roughly $9 billion (worth about an eighth of Altria's market cap) that it has yet to do anything with.
The bottom line? Altria must do something other than sell smokable tobacco products to be around for the long term, but that's not today's problem. In reality, it's probably not even a 2020s problem.
The company's financials are still too flexible, and its products seemingly have a solid runway left for future price hikes. So if you're looking for a dividend stock you can count on, Altria and its 9% yield still fits that bill.
