Is Altria A Good Investment At P/E Of Ten?

Altria is a legendary tobacco company which was split in two in 2008 when Philip Morris became the international part of the cigarette business while Altria distributes cigarettes only in the US. In 2019 the companies tried to merge (again) but it was postponed.

Tobacco stocks have been the best performers over the last 100 years. I have previously written about why so-called “sin-stocks” have performed so exceptionally well. Based on this I set up a portfolio of sin stocks in July 2020.

The current situation around Altria reminds me about Microsoft after the GFC in 2008/09: Microsoft was regarded as dead money, despite growing EPS solidly in the decade following the dotcom crash in 2000. In 2010 Microsoft was trading at 10 times earnings (Intel as well), about the same as Altria is today. However, Microsoft remained cheap for several years until June 2013 when the shares “took off” from its base at 30 USD a share. Microsoft is now trading at 208 per share and has a market cap of 1 600 billion USD (!). The main reason for Microsoft’s spectacular performance is not the earnings growth, but Mr. Market. Mr. Market’s mood has swung from depressive to exuberance: Microsoft was valued at 10 times earnings in 2010, while today the market values Microsoft at 35 times earnings. A quick calculation tells us the EPS has multiplied 2.5 times, while the share price has multiplied 7 times.

The market sentiment for Altria seems (to me) to be pretty similar: Altria has witnessed multiple contraction over the last five years, despite growing EPS and cashflow solidly. I don’t expect Altria to do as well as Microsoft has since 2013, but at today’s valuation Altria seems like a bargain.

Let’s have a quick look at Altria’s numbers:

Altria’s business:

  • Cigarettes: The business is called Philip Morris USA. Marlboro has been the best-selling brand the last 45 years (in the US).
  • Smokeless products: The subsidiary is called US Smokeless Tobacco (USSTC). USSTC joined Altria in 2009.
  • Cigars.
  • Wine (this is the smallest segment and has little impact on earnings).

Additionally, Altria owns three strategic investments:

Altria owns 10% of the world’s biggest brewer, Anheuser-Busch (BUD), currently worth around 10 billion.

In December 2018 Altria bought 45% of Cronos (CRON), a cannabis company, for 1.8 billion. The ownership has currently declined in value to 1 billion. At the same time Altria acquired a 35% strategic ownership in JUUL Labs, a vaping company, for 12.8 billion. This investment has thus far hit the earnings pretty hard: a 8.6 billion write down in 2019. Additionally, the Cronos investment was written off by 640 million.

JUUL has been hit by the regulators and market share dropped from 80% in 2018 to 60% in 2019.

What was the reasoning behind the Cronos and JUUL investments? I believe the main reason is the vast experience Altria has in dealing with regulations and litigations. JUUL was already under pressure due to concerns about youth use of its products. So far we can safely say the investments have been bad, but Altria takes a long-term view, of course.

Cigarette shipments are declining:

Smoking has been on a steady decline since 1970 when it was determined for a fact that smoking is bad for your health. Despite this, Altria has continued to increase EPS at an impressive rate.

Altria’s cigarette shipments. Left axis is billion cigarettes shipped, right axis is YOY percentage decline. Source: Annual reports.

Despite the drop of 40% of cigarettes shipped, Altria has managed to grow earnings and cashflow:

Altria earnings per share, dividend per share and free cashflow per share. Source: Annual reports.

Pretty impressive, if you ask me. Part of this is due to buybacks: the number of outstanding shares have declined from 2.079 billion in 2010 to 1.865 after 1Q 2020 (10.3% reduction). Buybacks are currently suspended to preserve cash during Covid-19.

The operating profits/income reads like this between the segments:

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Cigarettes 4 866 5 055 5 618 5 737 6 239 7 063 6 873 7 569 7 768 8 426 8 408 9 009
Smokeless N/A 381 803 859 931 1 023 1 061 1 108 1 177 1 306 1 431 1 580
Wine 61 91 104 134 152 164 146 50 -3
Other -185 -169 -99 -51 -421 -16

Clearly, smokeless has contributed significantly over this period.

Conclusion:

Cigarette shipments have declined at a CAGR of 4.5%, but still free cashflow per share has risen at a CAGR of 11.3% over the last decade. Pretty impressive.

The question is: Is this likely to continue?

Yes, I believe so. The trend of falling cigarette shipment being offset by higher prices has continued for a long time. In the US a pack of 20 cigarettes costs around 8-9 USD, while a similar pack costs around 11-14 in Europe. In Australia a packs costs closer to 20 USD (source: Morningstar).

But what about the current economic crisis? Marlboro is a premier brand, and the current economic crisis most likely makes the most price sensitive smokers elect cheaper brands. However, smokers are extremely loyal to their brands. The GFC saw a drop in demand, later partly reversed.

The past is of course no guarantee that we will see a similar pattern in the future. But we have seen this before: when tobacco advertising was banned in 1999, the tobacco stocks traded at very depressed levels, which in hindsight was a fantastic buying opportunity. I suspect today is not very different.

 

Disclosure: I am long Altria. I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.  

(This article was published on the 23rd of July 2020.)

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