This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.
It is often the case that in the world of dividend stocks, investors have to choose between dividend growth and dividend yield. Some stocks have the ability to raise their dividends every year, but many of these have low starting yields. On the other hand, high-yield stocks often pay the same dividend for years on end, as they do not possess the ability to raise their dividends from the current level.
On rare occasions, investors can find stocks that offer a combination of high yield, plus dividend growth. Altria Group (MO) is a good example of this. Not only does Altria have a current yield above 9%, it has raised its dividend for over 50 consecutive years. Altria is a Dividend King with a secure payout, and should continue to raise its dividend for many years moving forward.
Altria sells cigarettes, chewing tobacco, cigars, e-cigarettes and wine under the Marlboro, Skoal, Copenhagen, and St. Michelle brands, among others.
Altria continues to generate steady fundamental results, even in a difficult economic environment. Second-quarter revenue of $5.06 billion fell just 2.5% year-over-year, slightly beating expectations by $20 million. Smokeable product volume (which refers to the core cigarette brands) declined 8.7% year-over-year, a full percentage point better than expectations.
For the quarter, adjusted earnings-per-share came to $1.09, up 1% year-over-year thanks to effective cost controls and share repurchases. For 2020, Altria expects its adjusted diluted EPS to be in a range of $4.21 to $4.38, compared with $4.21 generated in 2019. Altria’s adjusted EPS could rise as much as 4% in 2020, which would indicate another successful year of growth despite the challenging economy. We expect Altria to continue its steady earnings growth in the years ahead, thanks largely to its growth investments in new categories.
Investing For Growth
In recent years, Altria has responded to the continued decline in smoking rates in the U.S., by diversifying its product portfolio. It has category-leading brands across smokeless tobacco, wine, and it also owns a 10% investment in beer giant Anheuser-Busch InBev (BUD). It has also made investments in new growth categories, particularly heated tobacco, vaping, and marijuana.
Altria has separately acquired a 35% stake in e-cigarette maker JUUL, and a 45% stake in the marijuana company Cronos Group (CRON). Altria also invested $372 million to acquire an 80% ownership stake in Swiss tobacco company, Burger Söhne Group, to commercialize its on! oral nicotine pouches. Finally, Altria is aggressively expanding its own e-cigarette brand IQOS.
Another major catalyst for Altria is its own heated tobacco product, which is marketed under the brand name IQOS. Altria acknowledges the shifting consumer landscape in regards to cigarettes. It has responded by investing in a new heated tobacco product line, which the company states has fewer harmful effects. In July, IQOS received approval from the FDA to be marketed as a modified-risk tobacco product.
These catalysts are likely to materialize in the form of higher growth for Altria, as the company has tremendous competitive advantages. It has the most valuable cigarette brand in the U.S., Marlboro, which commands greater than a 40% domestic retail share. This gives Altria the ability to raise prices to drive revenue growth.
Another benefit of Altria’s business model is that it is highly resistant to recessions. Cigarettes and alcohol sales hold up very well during recessions, which keep Altria’s profitability and dividend growth intact. This explains how Altria has been able to generate strong free cash flow in 2020, and continue to raise its dividend.
Altria is a very shareholder-friendly company. It maintains a target dividend payout ratio of 80% of its annual adjusted earnings-per-share. The company also returns cash to shareholders through buybacks. It is clear that Altria has been successful in its capital allocation program. From 2015-2019, Altria utilized $7 billion for share buybacks, and another $25 billion for dividends.
Valuation & Expected Returns
Altria stock appears to be significantly undervalued based on its current share price. Our estimate for Altria’s full-year earnings is $4.27 per share. Based on this, Altria stock trades for a price-to-earnings ratio of 8.7. We see this valuation multiple as too low for a high-quality business that generates steady profits, even during recessions. Therefore, our fair value estimate is a price-to-earnings ratio of 11.0.
As a result, Altria stock appears to be undervalued based on our fundamental analysis. This is an important consideration, as an expanding P/E multiple could fuel positive shareholder returns, through a rising share price. For example, if Altria’s P/E multiple increased from 8.7 to 11 over the next five years, it would increase shareholder returns by 4.8% per year.
In addition, we expect ~3% annual earnings-per-share growth through 2025, which will consist of modest revenue growth as well as share repurchases. Lastly, Altria stock has a high dividend yield of 9.3%. In total, Altria stock has total expected returns above 17% per year over the next five years. This is a very attractive expected rate of return, which makes Altria stock a buy for value and income investors.
High-yield stocks typically do not raise their dividends each year. At the same time, stocks that are able to raise their dividends reliably each year, often have lower starting yields. Altria stock is a unique mix of dividend yield and growth. It has a current yield over 9%, while the company has increased its dividend for over 50 years in a row.
The company is seeing some headwinds, specifically the coronavirus pandemic and a steady decline in cigarette smoking. But Altria has prepared for this with investments in new growth categories such as heated tobacco, vaping, and marijuana which are poised to fuel its growth going forward.
Disclosure: The author is personally long MO