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Altria Stock Gets an Upgrade: 3 Things You Need to Know

By Rich Smith - May 9, 2016 at 1:00PM

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Argus Research thinks wine could be the cure to what ails Altria's tobacco business.

It's another red day on Wall Street, with the Dow down a fraction of a percent to start the week. But one company's ticker is glowing bright green. Altria Group (MO 1.12%), whose stock has beaten the market's performance by 25% over the past year already, is up again today, by nearly 0.7% today.

For this, you can thank the friendly analysts from Argus Research.

The news
Altria stock currently costs a bit more than $63 a share, but according to Argus Research, it's worth closer to $68. Upgrading the shares from hold to buy this morning, Argus cited three prime factors underlying its optimism.

Here's what you need to know.

Altria is the artist formerly known as Philip Morris. Image source: Altria.

Thing No. 1: The balance sheet is rock solid has a great write-up on Argus's key points in favor of buying Altria stock this morning, and the first of these concerns the balance sheet, which Argus characterizes as "strong."

How strong is it? Well, Altria stock carries $12.8 billion in long-term debt. But according to data from S&P Global Market Intelligence, Altria also boasts $3.8 billion in cash on hand -- up $1.4 billion from just three months ago. And how did they do that? By keeping the cash flowing. S&P Global data further shows that over the past 12 months, Altria stock has churned out $5.8 billion in positive free cash flow, versus reported net income of only $5.4 billion. Simply put, Altria generates significantly more cash profit than its income statement lets on.

Thing No. 2: Altria shares the wealth
Much of that cash production goes into the company's coffers, but Altria isn't stingy about sharing the wealth, either. Another of the factors that attracts Argus to the stock is its "attractive dividend yield."

Altria currently pays out a 3.6% annual dividend yield to its shareholders -- $2.26 for every share you own. That's not as generous as foreign-focused companies such as British American Tobacco or Philip Morris International pay, unfortunately. But it is a bigger dividend than you'll get from U.S. competitor Reynolds American (RAI). Reynolds American stock pays out 3.4%.

Thing No. 3: Would you like wine with that?
So far, so good. Altria is a cash monster, and no dividend miser. It's Argus's third point in favor of Altria stock where the argument starts to get tenuous, and you begin to get the sense that this analyst is reaching for reasons to recommend Altria stock.

Addressing the elephant in the room (government regulators' distaste for cigarette stocks), Argus notes that Altria has "lessened its exposure to tobacco industry risks by expanding into nontobacco-related businesses." But while that's true on its face, it's still pretty inconsequential.

A review of Altria's three main business segments shows that -- first of all, there are three business segments, and not just one. Smokeable products continue to be Altria's biggest business at $16.4 billion in annual revenue, and this still makes up 87% of the company's business. Second in size is smoke-less products, such as chewing tobacco. At $1.7 billion in trailing revenues, that makes up a further 9% of Altria's business. As for the remaining 4%, that derives from Altria's wine business -- which contributed a whopping $668 million over the past year.

The most important thing
Does $668 million in wine revenue make Altria less dependent upon tobacco? Marginally, yes. And the wine business isn't necessarily even bad for Altria. (In fact, the company earns quite respectable 23% operating profit margins on this business.)

But even so, over the past year, Altria's wines business has grown only from $459 million annually to $668 million. Thus Altria added $209 million in new alcoholic revenue to its business -- but over the same period, Altria lost $5.8 billion in annual revenue from tobacco. What's more, Altria's lost tobacco sales brought in much fatter profit margins than the wine that now replaces them produces -- 46% versus 23%.

Simply put, wine is a poor replacement for tobacco, revenue-wise, and profits-wise, as well.

What does it mean for investors?
So where does this all leave Altria investors today? Well, the stock is selling for nearly 24 times earnings at last report. Analysts who follow the stock generally think Altria can keep growing earnings at 8% annually over the next five years, resulting in a PEG ratio of about 3.0 on Altria stock.

Personally, I think that's too much to pay for a tobacco stock whose flagship business is withering on the vine. And no amount of wine is going to change that opinion.

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