Altria - Part 1
This cigarette butt might have one last puff left in it
A couple of weeks ago I mentioned that I had opened a new position in my Portfolio, that new position was Altria, ticker symbol $MO.
Let’s talk about that.
What is Altria?
As per Wikipedia, Altria is:
Altria Group, Inc. (previously known as Philip Morris Companies, Inc.) is an American corporation and one of the world's largest producers and marketers of tobacco, cigarettes and related products. It operates worldwide and is headquartered in unincorporated Henrico County, Virginia, just outside the city of Richmond.
In other words, Altria is an American Tobacco manufacturer which operates worldwide.
That being said, that “worldwide” label is a bit misleading. While it is certainly true that Altria has global business, its core revenue streams come from its tobacco sales in the USA. Specifically in 2008 they split off their international business into “Phillip Morris International”, a separate company who manufactures and sells tobacco everywhere other than the USA.
Altria primarily operates their business in the US and is exposed to the US market in that way, with their international businesses being a sideshow.
Altria is a dividend aristocrat, who has increased their dividend yearly for 51 years.
Strengths and Weaknesses
Let’s be clear here, Tobacco is an unhealthy, unseemly product that is highly taxed and regulated pretty much everywhere in the world, including the USA.
This naturally impacts the strengths and weaknesses of the company.
Consistently High Operating Margins
High Brand Recognition and customer loyalty
Demonstrated and consistent return of capital to shareholders through dividends and share buybacks
Highly regulated industry imposes barriers to entry to new competitors
High taxation reduces earnings
Non-traditional competitors are disrupting the industry
Few opportunities for growth
Tobacco, much like Alcohol and prostitution is a “sinful industry” for which there is widespread public opposition, with the corresponding political pressure against the industry.
This public pressure has resulted in a reduction of the size of the industry, as well as continuously increasing punitive regulation against the industry.
These trends are not likely to stop anytime soon, and so an investment in Altria is necessarily an investment in a shrinking industry that is out of favor.
That being said, the underlying economics of the industry are still good, and much like Ben Grahams “cigarette butts” there may still be some value in this industry, and in this company in particular.
Let’s have a look at their numbers over the past 10 years:
There’s a lot of data there, so let’s break that down a little bit.
In terms of revenue we can see steadily increasing numbers, though the increases are very slight (roughly 1% per year), and primarily the result of increased prices, since the number of smokers has been declining over the years.
The gross profit too shows a nice upward trend, primarily the result of decreased costs, giving a CAGR of around 3.83%.
In terms of interest expense it’s remained fairly steady over the decade.
There’s 2 interesting entries here though, the ones related to JUUL and Cronos.
These are one off impairment of goodwill charges that severely hurt the net income of the company in these past 2 years. These are non-cash charges, and relate to Altria Cannabis and Vaping subsidiaries and investments. We will talk more about this later in the Story portion of this deep dive.
The final thing that I want to point out is that even with those 2 years where there were significant impairments, the average pre-tax margin is still around 34%.
That’s a gigantic number that really shows the massive earnings power of the company. These are margins you usually only see in high quality tech companies like Microsoft.
It’s fairly clear that their earnings power is what we are buying when we buy Altria.
What about their Per-Share metrics?
We can see a steady decline in outstanding shares (around 1% CAGR), as well as slight increases in the per-share earnings (around 4% CAGR).
If you’ll remember we previously established that stock market returns are almost entirely explained by dividend yield plus the earnings growth.
For Altria, assuming no dividend cuts and continued earnings growth in line with the past 10 years, that would mean we can look forward to around 11.5% return. Not bad for a “dying” business!
An interesting balance sheet to say the least.
The stockholders equity is almost zero, the result of consistently returning capital to shareholders via dividends and share buybacks, just look at that cost of repurchased stock, that’s all value returned directly to shareholders!
The long-term debt is the largest liability, but two or 3 years of operating income is more than enough to clear it all up.
Altria is clearly a highly leveraged company, but their earnings power is so high, and their capital requirements so low that they can easily pay it all off in just a couple of years if they make it a priority.
Why do I say that?
Because the main entries in the balance sheet aren’t related to keeping and running their core business. To be more specific the Goodwill and the Investments in Equity securities which compose most of their assets correspond to their (partial) ownership of non-core businesses like JUUL, Cronos, and so on.
These are important investments no doubt about that, but they are not what is driving the bulk of the operating income. Even if they were to be meaningfully impaired, they would not effect the operating profitability of Altria, at least not in the short term.
In other words, Altria has very high returns on invested capital for their core business, without a large need to reinvest that capital or perform costly capital expenditures.
What is happening here is that essentially Altria is using the oodles of cash being generated by their core tobacco business using very little capital, and investing that money into alternatives that might seek to disrupt that core business. That is the case with JUUL, a vaping company that is disrupting the smoking industry.
What is up with this valuation?
It’s fairly clear as to what is happening here.
Altria is a boring un-sexy company in an industry that is being regulated out of existence, and so it is out of favor with investors because of that.
The ESG trend too is causing some investors to stay away from investing in Altria and other tobacco companies, further depressing the prices.
This means that there is an opportunity here for a discerning investor to potentially purchase the earnings of this company for less than they are worth.
The way I see it, Altria is a classic cigarette butt as described by Ben Graham, and as long as I can purchase it for the right value I might be able to turn a tidy profit.
Of course that depends on the price I pay for it, and the price I think the company is worth. We will calculate that in the next post!
Let me know what you think!
And as always, if you have any questions or comments, shoot them on Twitter @TiagoDias_VC or down below!
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