Altria - Part 3
The story of this cigarette butt
We’ve been reviewing Altria, an American Tobacco company with an attractive valuation that is being hampered by heavy regulation intended to destroy the tobacco industry.
Today, we will be having a look at the risks involved with investing in Altria, the benefits, and possible steps that the company will take to address them.
Dividends and Dividend Growth
Altria is a Dividend King with a whopping 51 year track record of increasing dividends. At first glance this might seem untrue, indeed if you have a look at their investor relations website, you will see this chart:
The reason for the decrease in the late 2000s was due to the back to back spin offs of Kraft foods and Phillip Morris International. In both cases investors kept shares in the spin offs, and the total dividend remained roughly the same.
Dividends, and their sustainable growth, are a key focus of the company, with the company maintaining a long-term objective of a dividend payout ratio target of approximately 80% of its adjusted diluted EPS.
While any future dividend payments are of course up to the discretion of the company and the board of directors, and reliant on the performance of the company, there is every indication that if possible, Altria will continue paying out increasing dividends going forward.
Margins and Earnings Power
Dividends are ultimately driven by earnings, and this situation is no different for Altria.
Ultimately a bet on Altria is a bet on their ability to continue to maintain their margins, and grow their earnings.
The future doesn’t look particularly bright there, though earnings growth in the 4% to 6% range seem viable for the near future.
That is inline with their own estimates for the upcoming year, and the 10 year average.
Tobacco is a very sticky product, and branding does have a high influence in consumers purchasing decisions. Altria, with its well known and established brands naturally has an advantage here, and as long no major pitfalls happen, they will be able to keep that up for the next decade or so.
Regulation and other risks
Regulation, litigation and other forms of regulatory are now, and will be the primary risk involving Altria.
Altria recognizes that, and in their latest 10-K report have stated the following:
Legal proceedings covering a wide range of matters are pending or threatened in various United States and foreign jurisdictions against Altria and its subsidiaries, including PM USA and USSTC, as well as their respective indemnitees, indemnitors and Altria’s investees.
Legislative action, such as changes to tort law, also may expand the types of claims and remedies available to plaintiffs.
Litigation is subject to uncertainty and it is possible that there could be adverse developments in pending or future cases.
An unfavorable outcome or settlement of pending tobacco-related or other litigation could encourage the commencement of additional litigation.
Damages claimed in some tobacco-related or other litigation are significant and, in certain cases, have ranged in the billions of dollars.
This is not a small risk, and indeed there are multiple pages dedicated to outlining the regulatory risks involved with Altrias business, ranging from punitive levels of taxation to Health and Safety related regulations that are ever changing and continuously getting stricter, to even anti-trust actions that may be taken against Altria and its expansion to new products.
In general almost all of the risks outlined by Altria in their annual report involve some kind of regulatory action that is either in progress, or likely to take place in the near future.
This is not a small risk.
But ultimately it is one that is unrelated to the quality of the underlying business, which is, for the most part, solid and highly profitable.
Altria is committed to Moving Beyond Smoking and from their Q2 2021 press release means to do that by “deepening their understanding of adult tobacco consumer preferences, expanding the awareness and availability of our smoke-free product portfolio, and amplifying our voice on harm reduction within the scientific and public health communities “.
In other words, they are attempting to pivot their business model from a burnable tobacco products model, to one focused on smoke free products.
This is in line with the regulatory incentives in place which mean to discourage and reduce tobacco usage in the general population.
It’s for this reason that Altria has made heavy investments in alternatives to tobacco, particularly in the Marijuana and Vaping segments. They are hoping to use this, alongside the heated tobacco segment to modernize the company and move it towards a less regulated business.
Their plan , according to their own investor presentations, is to “Maximize profitability in combustibles, while appropriately balancing investments in Marlboro with funding the growth of non-combustible products “
These initiatives, although less profitable than their traditional business, will hopefully provide a path to profitability away from regulatory scrutiny, or better yet, they will be able to make use of their involvement in the Marijuana regulation movements to drive any upcoming regulation in that sector to a position that is beneficial to established players like Altria.
In other words, even though right now these segments may not be the bread and butter of the company right now, they are able to do 2 things.
First they may slow regulation in the tobacco space, allowing Altria to continue operating this high margin business for longer.
Second, they may be able to drive some of the regulatory capture in the new segments, preventing new entrants, and driving whatever regulations do come to a positive conclusion.
You know the answer already, I bought the company a couple of weeks ago, and so I am giving Altria a BUY rating.
Let me be clear, this is a risky play, Altria is facing severe headwinds, and I may well be wrong in my valuation of them.
But even with the potential pitfalls, the company is providing a highly attractive dividend yield which makes the risk/reward ratio of investing in it extremely attractive.
Do you agree? Disagree?
Am I making a huge mistake? Is Altria going to overcome the regulatory hurdles?
Let me know what you think in the comments down below!
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And as always, if you have any questions or comments, shoot them on Twitter @TiagoDias_VC or down below!
I’ll see you next time!