Today's Buy Opportunity: Altria

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Today, my 11 O'Clock Stock is sin purveyor Altria (NYSE: MO) -- the company behind Marlboro cigarettes, Copenhagen and Skoal smokeless tobacco, and quarter-owner of the beer behemoth SAB Miller. Altria's not for every investor for a variety of reasons detailed below, but let's first look at a quick overview of the company:

Fast facts on Altria:

Source: Capital IQ, a division of Standard & Poor's. TTM is trailing 12 months.

I'm going to do something a little unorthodox today, by giving you 10 reasons NOT to buy Altria, in no particular order. Then I'll tell you why I still made Altria today's "11 O'Clock Stock" pick.

You shouldn't buy Altria because...

1. It's a sin stock -- you may have moral qualms.
2. At around 90% of sales, cigarettes are Altria's major product -- and cigarette volume in the U.S. is declining by about 3%-4% a year as health-consciousness and smoking bans decrease demand.
3. It's highly leveraged, with a debt/equity ratio above 2.5:1.
4. The interest rate Altria pays on that debt is quite high, because it took on onerous terms (near-10% interest rates on a ton of debt) to acquire smokeless tobacco producer UST (parent of Copenhagen and Skoal) in early 2009.
5. The company's litigation risk will likely never go away.
6. Altria spun off its international cigarette business as Philip Morris International (NYSE: PM), leaving it fully exposed to the declining, litigious U.S. market.
7. Excise taxes are hefty and a good way for governments to make money easily. Expect them to continue rising.
8. Smoking bans are ever-increasing.
9. The FDA tightly regulates the cigarette market.
10. When you're at the top of your industry, there's only one way to go, right?

And it gets worse...

I'd shudder in terror at most companies that hold such high levels of debt AND commit to paying a 6.3% dividend yield. Between interest payments and dividends, that's a lot of regular cash commitments outside the utilities sector. Even looking at utilities, Duke Energy (NYSE: DUK) and Exelon (NYSE: EXC) are less leveraged (78%-94% debt-to-equity) and have lower dividend yields (5.7% and 5.1%, respectively) than Altria.

The redemption
But know this: Altria's No. 1 product isn't cigarettes ... it's cash flow. It's an absolute cash flow machine, pumping out the green stuff plentifully and steadily.

It generates huge cash flows (in absolute terms and as a percentage of sales) because its brands dominate the U.S. tobacco industry and it has immense pricing power.

Take a look at Altria's market share:

Source: Morningstar.

Reynolds American (NYSE: RAI) (Camel, Winston, etc.) and Lorillard (NYSE: LO) (Newport, Kent) are major players, but Altria's Marlboro brand is dominant with a 42% market share by itself.

As an industry, tobacco companies in general have pricing power; Econ 101 professors use cigarettes as their go-to example of inelastic demand. For those who slept through class, inelastic demand pretty much just means pricing power. So cigarette companies can raise prices to more than offset decreasing cigarette volumes. And Marlboro's the best brand in the business.

Let me show you another picture to illustrate how much pricing power Marlboro has:

Source: Altria.

Translation: Consumers are willing to pay 34% more for a pack of Marlboros than the cheapest alternative.

The bottom line
Altria has a lot of risks (like increased levels of litigation, excise taxes, and regulation), but they're known risks. Although it's hard to quantify those risks, at least we know to include them in our analysis. Think of the damage done to the stock prices of BP (NYSE: BP) and Toyota recently as examples of risks that no one saw coming.

I believe Altria's dividend stream, its brand dominance, and its pricing power make it an excellent addition to a balanced portfolio. For folks looking to add a new position, Altria is reasonable at current prices (around $22 a share), attractive below $20 a share, and a great deal below $18 a share.

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