Another year, another dividend increase for tobacco giant Altria Group (MO 0.81%). In August, the company approved a 4.3% increase to its quarterly dividend. It's now paying $0.98 per share, or $3.92 on an annualized basis. The Dividend King has raised its dividend payout for 54 straight years, one of the best track records ever.
At the $3.92 annualized payout, Altria boasts a dividend yielding over 9%. Investors have become pessimistic about tobacco stocks in recent years, which explains the high yield. Shares are down 31% in the last five years, even though the dividend per share has gone up 31% over the same period. Does that make Altria the right income stock to buy for your portfolio today? Let's take a look.
Lower volumes, higher prices, more profits
At its core, the driver of Altria's business is the Marlboro cigarette brand. The premium smokes are the leading product among tobacco users in the United States, holding a 40% share of industry sales.
While its market share has remained stable, cigarette volumes have declined steadily over the last few decades. According to Altria management, the percentage of cigarette users in the U.S. is declining at around 2.5% a year. So how does Altria increase its profits and grow its dividend? Two words: price increases.
Tobacco companies have generally counteracted any volume declines by increasing the price of a pack of cigarettes, which leads to revenue growth. It is modest growth but growth nonetheless. Over the past 10 years, Altria's revenue has grown 16.8% even though volumes have declined significantly.
What is misunderstood by most investors is the margin expansion that comes along with price increases. Since Altria is earning more revenue on fewer products sold, its margins tick steadily higher as it increases prices, all else being equal. This is why operating income has grown 44% in the past decade, nearly triple the pace of its revenue growth. As prices continue to go up for packs of Marlboros, this dynamic should continue over the next 10 years.
New lever: buybacks
After pausing it during the pandemic disruptions, Altria's management has resumed its share repurchase program. Since the spring of 2021, shares outstanding have fallen from around 1.86 billion to 1.77 billion today, a 5% decline in just over two years. While seemingly a small change, share repurchases can have compounding effects over the long term that will help Altria fulfill its dividend payouts.
Let's illustrate this dynamic with an example. Today, Altria's $3.92 annual dividend equates to $6.96 billion in total dividend obligations. On its spring 2021 share count of 1.86 billion, the same payout would equate to $7.29 billion in dividend obligations over the next 12 months. This means its recent share repurchases have saved the company about $330 million while it continues to grow its dividend.
If Altria can reduce its shares outstanding by 5% every two years, it will have a lot more breathing room to grow its payout despite declining cigarette volumes. That's the beauty of a consistent share repurchase program.
Can the dividend continue to grow?
With a payout ratio hovering in the low 40% range, it is pretty clear Altria has the firepower to maintain its generous dividend. The company has grown its operating income at a healthy pace in the last 10 years and is reducing its share count after a pandemic hiatus. We haven't even talked about its successful entrance into the nicotine pouch business, which has grown its sales volume at an impressive rate in recent years. This could turn into a major area of expansion for Altria going forward and even help accelerate revenue growth.
Put all of these pieces together, and Altria looks like a fantastic bet for income-focused investors.