When it comes to understanding a stock's success, not many cases are more baffling than cigarette giant Altria (MO -0.37%). Despite health hazards, addiction issues, and lawsuits that have hammered Altria's main product over the years, the stock delivered massive growth and dividend returns for decades.
However, the burdens of such challenges have seemed to weigh on the stock in recent years, and it has started to underperform the market. That should leave investors wondering if its struggles will finally derail the tobacco stock for good, or if the company will find a way to continue prospering.
Beating the odds
Admittedly, few companies have more successfully defied bearish trends than Altria. Smoking was a widely accepted practice in 1964, when the surgeon general released a report linking smoking to lung cancer.
Due to the addictive nature of tobacco, change came slowly. Still, as the health risks and addictive nature of the product became more apparent, victims of lung cancer began to sue cigarette companies. Those lawsuits culminated in a master settlement agreement in 1998 that cost the industry $206 billion over 25 years.
Yet that agreement did not stop the stock price or the dividend from rising. Last year, Altria hiked its dividend payout 4% to $3.92 per share annually. At its current share price, that gives it a dividend yield of 9.7%, far above the 1.4% average of the S&P 500. The company has also continued to raise the prices of its cigarettes, and the addictive nature of tobacco likely mitigated what might have otherwise been a rapid decline in product sales.
What has changed
However, the addictive nature of tobacco did not prevent a decline in use over the long term. According to the Centers for Disease Control and Prevention, less than 12% of U.S. adults smoked cigarettes in 2021. That was down significantly from 2005, when the rate was 21%, and well below 1964 levels, when an estimated 45% of U.S. adults smoked.
Over time, this has reduced sales for Altria, which has led it to attempt pivots into other businesses, buying smokeless tobacco company Juul and a massive stake in Cronos Group, a Canadian cannabis company.
Unfortunately, the Juul investment led to a $462 million settlement with six states. Also, Altria booked a $483 million capital loss from its Cronos investments, and abandoned an expiring stock warrant on Cronos shares that would have given it a majority stake in that company.
Altria still holds just under 157 million shares of Cronos and is trying again to make inroads in the vaping niche by buying vaping company Njoy in mid-2023. Nonetheless, cigarettes remain its largest source of revenue. Unless one of these businesses steps up to replace the revenues it's losing from declining cigarette sales, Altria's growth prospects are uncertain.
Additionally, its dividend cost the company $5 billion in the first nine months of 2023. Altria produced only $5.9 billion in free cash flow during that period. Hence, maintaining and increasing its dividend is leaving the company with little cash to use for other purposes. Furthermore, with Altria stock consistently underperforming the S&P 500 over the last five years, the impacts of rising dividend costs and falling tobacco use may finally catch up to Altria stock.
Is Altria stock a buy?
Given the state of the company's businesses and finances, investors should probably stay away from Altria stock. Admittedly, it has defied tremendous odds, delivering share price and dividend growth even after the public learned how damaging tobacco was to health, and even after it was forced to pay massive settlements. That alone may led investors to trust Altria's ability to find new growth avenues despite the uncertainty.
Nonetheless, tobacco use in the U.S. continues to fall, and Altria's moves into other businesses have so far failed. The combination of these issues dramatically increases the odds that management will at some point have to cut its dividend. If that occurs, and if income investors abandon Altria as a result, its investability could go up in smoke.
