Finding a stock with a high dividend yield isn't necessarily a home-run investment. Often, a stock offers a high yield because something is wrong. The dividend might be in danger, or the business outlook may be weakening, sending the stock price lower.
Those stocks could be traps. They might cut their dividends, and the stock price might keep moving lower. That's a double whammy for investors.
But there are a few companies that can generate consistent free cash flow that increases year after year. And with low capital intensity, they're willing to pay out a significant amount of that cash to shareholders.
Those companies can offer both a high yield and the potential for capital gains. One stock that fits the bill right now is Altria (MO -0.37%). Here's why Wall Street thinks the stock price could climb 30% next year even as it is paying out a dividend yielding 9.2% at the moment.
Altria won't go up in smoke
Despite the secular decline in tobacco users, Altria remains in a strong position to continue growing revenue and earnings. There's no secret to its success. Altria has tremendous pricing power, no doubt supported by its addictive product. Every year, a pack of its cigarettes goes up in price.
It holds a leading position in the premium cigarette category in the United States by a wide margin. Its Marlboro brand accounted for 42.1% of cigarette sales in the U.S. through the first nine months of the year. And when you look at only premium products, it accounted for 58.9% of sales in the third quarter. That market share and its focus on the premium market give it a lot more pricing power than its competitors.
Cigarette volume is decreasing faster than expected in 2023, down 10.5% through the first nine months of the year. That doesn't mean declines won't stabilize, though. Management points to macroeconomic uncertainty and the growth of unauthorized disposable vapes from China that are hard to account for. When the economic tide turns (inflation comes down) and the U.S. Food and Drug Administration (FDA) cracks down on illegal vapes, it will help cigarette volumes.
Price increases haven't quite kept up with the volume decline this year. Smokeables revenue is down 3.2% through the first nine months. Still, that's a strong performance in the face of industry weakness.
Altria is leaning into cigarette alternatives
In the meantime, Altria is shifting away from smokeables. Its acquisitions of NJOY and On! give it a firm standing in the growing e-vapor and nicotine pouch categories.
NJOY benefits from six marketing granted orders (MGOs) from the FDA, which allows the company to market its products. Just 23 e-vape products have received MGOs, which means the vast majority of products are unable to legally market. With the power of Altria's salesforce, it could meaningfully accelerate sales in the category for the tobacco company.
Altria sees its smoke-free revenue doubling from 2022 to 2028, reaching $5 billion in total that year. That represents nearly 25% of the company's trailing 12-month revenue. That can go a long way toward offsetting declining cigarette volumes.
Altria is seeing growing profits
Despite investments in cigarette alternatives, Altria has been able to push its profits higher thanks to its pricing power.
Altria's gross margin of 58.3% through the first nine months of 2023 is a 1.8-percentage-point improvement from the same period last year. Operating margin, adjusted for one-time expenses, has seen similar improvements.
While there's certainly a limit to how much Altria can raise its prices, it doesn't seem to have hit it yet. Cigarettes are still relatively affordable in the United States compared to many other developed markets. A pack of cigarettes in Great Britain, for example, costs 14.59 pounds ($18.41). You can buy a pack of Marlboros in many U.S. states for less than half that price.
As such, Altria should be able to keep growing its profits and free cash flow for years to come as it produces higher margins on its sales. That will inevitably translate into more dividend increases, as management has a track record of more than 50 years of giving shareholders a raise.
Altria stock is dirt cheap
Altria is a slow-growing company, and the stock shouldn't trade at an eye-popping valuation like many growth stocks. But with a share price just above 8.6 times management's outlook for 2023 earnings, the stock is really cheap.
Wall Street agrees. Jeffries analyst Owen Bennett sees the stock climbing to $56 in the next 12 months. That would put its price-to-earnings ratio at around 12 times the average analyst's 2024 earnings estimate and in line with its historical average.
If the stock price does climb to $56 a share, the dividend yield is going to fall. So, at its current price, Altria shares look like a great addition for anyone shopping for ultra-high-yield dividend stocks.
