Altria (NYSE:MO), as the 9th best performing stock in the S&P 500 over the last 30 years, has probably made some of you rich or really helped with your retirement. And the return over that period should be even greater because I don’t think they’ve factored in all the spin-offs. Over this period, you have also received shares in companies such as Philip Morris International, Kraft Foods Inc, Mondelez and Ralcorp.
The question now is whether they can continue to deliver annual returns in excess of 20%. And I have to say that I do not think they can. I would say they could deliver something in the low double digits. That said, as we saw in 2022, companies like Altria have their market environments where they can really outperform the market. In the next couple of chapters, I will show you why I think this is the case.
I usually write about smaller cap companies where there is not as much analyst coverage, because I think that is where you can have an advantage as an investor. And one of my recent articles was on Cronos (CRON), where Altria is invested, and Amcor (AMCR), which is using something like the Altria playbook without an addictive product to create shareholder value. So I thought I should take another look at Altria.
A “high” dividend that has been growing for a long time – 57 increases in 53 years for Altria – coupled with a share buyback program and an addictive product has worked like a cheat code. And they are trying to replicate that with their investments in cannabis, alcohol and other nicotine products. Without much success at the moment, but I could really see a similar success story to Altria in cannabis after global legislation. Or even in other dopamine rush products like energy drinks or social media. Addictive products always have the potential for high returns.
And tobacco companies are often high quality companies that I think are a nice addition to a portfolio. They often produce nice returns in tough times like 2022. Should they become trendy again, they could even benefit from serious multiple expansions.
There is no other way to put it, but the returns to shareholders over the last 5 years have been disastrous. So it has been very important over that period to reinvest dividends at the right time. But as we all know, market timing is not easy. But over the last 5 years, Altria has grown EPS and dividends, and one could argue that they are in a better position now than they were 5 years ago.
Tobacco stocks have not been the most popular in recent years, but with a changing environment that could change. But how will people react to rising interest rates over the next few years? Will they dump unprofitable tech stocks and move into dividend stocks? Or will they dump equities in general because they can get almost as much in savings accounts as they would in dividends without the risks?
In contrast to the 5 year chart is this 13 year chart just after they spun off PMI and Kraft in 2008 and 2007 and over that period they beat the S&P 500 by a whopping 2% per year. So the next 5 years are very likely to be better than the last 5 years because Altria is still a high yielding, cash generating company that is very shareholder friendly.
A very interesting interview about the tobacco market is this one with Terry Smith of Fundsmith. He mentions that the bans were almost an advantage for the big tobacco companies. After all, how can you compete with Marlboro if you can’t advertise? And because it was almost impossible to get new competition in cigarettes, it really helped them.
Full Year 22 Review
Like almost every year, the tobacco industry is in decline and is now down 1.7% over a 5 year period on a compounded annual basis. And the various segments have declined as follows, according to the latest 10-K:
- Cigarettes: 9.7% decrease
- Cigars: 4.0% decrease
- Oral Tobacco: 2.4% decrease
But the adj. dil. EPS, on the other hand, grew by 5%. In their last AGM presentation, they gave guidance for EPS growth of 4% to 7% in 2022. So this is at the lower end of the guidance. Most Altria investors look at EPS because they are invested for the dividend, so they put more emphasis on that than on the actual volume declines as long as Altria is making enough money.
Guidance for the EPS growth in 2023 is 3-6%, so it is a little bit lower than the year before. So a 5% increase would be more on the upper end of the spectrum. This figure will be important in the chapter where we look at the reverse DCF to see what is currently priced into the share price.
Basis is 2022 adj. dil. EPS of $4.84 and a discount rate of 10% because this is roughly the total annual return of the S&P 500. $46 Share Price / $4.84 = 9.5x multiple. But I have adjusted this to a multiple of 12 because historically it has been quite a bit higher than 9.5x. Nevertheless, it is priced into the share price that EPS must grow by around 8% over a 10-year period. However their own guidance is only 3-6% for the next year. At a lower multiple, they would have to grow by even more. It will be interesting to see how this plays out, as Altria looks cheap on an EV/EBIT multiple of ~8.5x. But the reverse DCF says that more growth is priced into the price than they are forecasting. Aside from this, some would argue that a reverse DCF on dividend payments would be a better measure.
But with dividend payments as the input we get the same picture, a growth rate of 11% over 5 years and then 5 years at 10% is priced in. But the actual 5-year growth rate is only 7.70%. All in all, prices below $40 are probably a better buying point. At the moment, they are slightly overvalued if you look at the growth rates.
Altria has advantages in EBIT, net income, and FCF margins. So, in a sense, they are more efficient in their allocation of capital. But this is important because from an earnings growth perspective, all of their peers are significantly better over a 5-year period.
If we assume that Altria could achieve an EPS growth rate of 3-5% per year over the next decade + a dividend of 7-8%, we could see an annual return of about 10-13%. Depending on the entry point, this could be a little better or worse. In summary, the days of 20%+ annual returns are over. But Altria can be used as a blueprint to find small companies with similar characteristics that have their best days ahead of them.