For dividend investors, a company's ability to increase its dividend is paramount to long-term returns. Altria Group (NYSE:MO) has raised its dividend 47 times in the last 44 years, which has given the market confidence in the company's commitment to dividend investors. Altria's payout ratio target -- 80% -- gives it little room to work with should earnings disappoint in any given year. However, the company's stake in SABMiller (NASDAQOTH:SBMRY) -- and recent rumors that it could sell the stake to Anheuser-Busch InBev (NYSE:BUD) -- should assure nervous investors that Altria can continue to increase its dividend for years to come.
What SABMiller means to Altria
Altria maintains a 26.8% stake in SABMiller, the world's second-largest beer brewer. Altria carries the stake at $6.7 billion on its balance sheet, which is about 15 times the $439 million in dividends Altria collected from the position in 2013. Before tax, the dividends from SABMiller were about 12% of the $3.6 billion in dividends that Altria paid its shareholders in 2013. This means that Altria's tobacco business provides the vast majority of cash flow for its dividend payments.
However, Altria could liquidate this stake for much more than its balance sheet valuation. SABMiller grew earnings per share at 13.3% per year from 2004 through 2013, including $2.09 per share over the last four quarters. As a result of this impressive growth, the stock trades at 27 times trailing earnings, or $92 billion, which gives Altria's stake a $24.7 billion market value.
Selling the stake would provide ample liquidity for the dividend
Moreover, there has long been speculation that Anheuser-Busch InBev could acquire SABMiller in a merger valued at over $100 billion. A merger of No. 1 brewer Anheuser-Busch InBev and No. 2 brewer SABMiller makes sense from a geographic perspective; SABMiller derives 33% of its operating income, excluding depreciation, from rapidly growing Latin American markets, especially Columbia and Chile. This would provide growth and geographic expansion for InBev, which could in turn provide SABMiller with wider distribution in developed markets and greater economies of scale in production and distribution.
A cash-and-stock merger would provide billions in cash that Altria could use to pay dividends to its shareholders and the company could liquidate the rest over time as needed. If Altria liquidates its stake for $27 billion, it would be left with $15.93 billion after paying 41% in state and federal taxes. That's enough to fund its current dividend for four more years.
Of course, Altria's tobacco business will continue to generate billions in cash flow to pay an ever-higher dividend. The company's free cash flow totaled $3.8 billion in 2013, excluding SABMiller dividends. Altria usually increases its free cash flow each year because it raises cigarette prices to offset volume declines, but the company can cover its dividend even if free cash flow never grows again.
If free cash flow remains at $3.8 billion, Altria can pay a dividend that grows at 6% per year through 2024, assuming it sells its SABMiller stake for $15.93 billion after tax. Given that Altria can grow free cash flow at a mid-single-digit pace for many more years, the company can continue to grow its dividend far beyond 2024.
The likely course of action
My Foolish colleague, Rupert Hargreaves, argues that Altria will not sell its SABMiller stake for tax reasons and the diversification the brewer provides. Altria CFO Howard Willard III echoed this sentiment on a recent conference call, gushing about the growth and diversification that SABMiller provides. Ultimately, Willard believes retaining the stake is in shareholders' best interest.
Altria's payout ratio seems high, but its stake in SABMiller provides ample room to grow its dividend even if earnings slip. Even though the company is not keen to liquidate its holding just yet, Altria will do whatever is in the best interest of shareholders. That means that if it doesn't liquidate its stake, holding onto it should create even more value. So shareholders should rest easy knowing that Altria's dividend is well-covered.