IMBBY - Altria: Low Growth But High Income

2023-06-30 16:22:13 ET

Summary

• Altria has raised its dividend for 53 consecutive years and is predicted to increase it by $0.04 to $0.98 in the next quarter.
• The company has faced a tough couple of years, with its share price oscillating with a slight downward tilt over the last five years.
• Altria's valuation is compared to British American Tobacco and Imperial Brands, its two largest competitors with a U.S. presence.

Altria (MO) has been keenly focused on rewarding its investors to the best of its ability for many decades on end. In fact, last year the dividend was raised for the 53rd consecutive year . In my latest article on the company, my prediction for the new dividend was off by one cent. So let's see if I can nail it this year.

The company has certainly had a tough couple of years behind it, though many companies would consider consistent single-digit earnings growth as nothing to sneeze at. As a dependable cash-flow generating investment, Altria delivers. However, the days of a combination of high single-digit growth rates and high single-digit yields are over and sadly not likely to come back.

For investors seeking a high current income and a long-term growth of that income at or above long-term inflation, Altria is a very good stock to have in the portfolio. Just don't dream of those 20% annualized returns this company used to produce in the good old days.

As we can see in the graph above, the share has been oscillating with a slight downward tilt over the last five years. Not the kind of development most investors are looking for. The stock is down from about $57 to about $45 for a $12 loss. Luckily, though, when adding in the annual dividend which has averaged around $3.5, we can turn that $12 loss to an approximate gain of $5. Still, there's no denying that investors would and should have expected more than a dollar a year. In short: Though the very long-term returns have been impressive, recent historical returns have been disappointing.

Historical Dividend Growth

MO is closing in on six decades of annual dividend growth. That is some achievement! What's more, unlike some companies like Coca-Cola (KO) or Procter & Gamble (PG) which have maintained their dividend growth streaks by offering very low growth rates for many years, Altria has managed to stay at least at or above long-term inflation rates. It's certainly nice to see your dividend grow, but when it's growing at just above 2%, as Coca-Cola's dividend did for several years, it' not really something to be excited about.

Altria's dividend doesn't grow at 8% anymore, but it does grow at 4.5%, which is comfortably above long-term inflation rates. Over time you can rely on the dividend income and that the purchasing power of that income stream will grow above inflation. Sounds like a perfect fit for people at or in retirement.

What sticks out in the chart above is the steady increase in the dividend. Works like clockwork every year. This is the kind of dependability a lot of investors are seeking.

Slightly more volatile, to say the least, is the payout ratio. The Board targeted an 80% payout ratio for many years but as we can see above, that target has rarely been met. The main reason is that the Board has targeted against the adjusted earnings per share number whereas the figures above are the reported numbers. As investors casually following Altria knows, there's been a lot of transactions and write-downs of failed investments over the last five years, which helps to explain the volatile number. On an adjusted basis, though, the company has tended to stay pretty close to the number. Consequently, there's been a pretty direct link between a slower EPS growth and slower dividend growth.

In May 2018 a dividend of $0.70 was declared. In May 2023, five years later, a dividend of $0.94 was announced . The 24-cent increase is equal to a 34% increase which again means the annual average growth rate was 6%. Last year it grew by 4.4%. True, the last couple of years have been especially difficult, but there is a clear long-term trend of slowing dividend growth. Fortunately, there are reasons to believe the downward trend has stopped, as we will take a closer look at below.

August Dividend Hike

The end of summer is for many a pessimistic period as the summer vacation is at an end and colder and darker times are ahead. For Altria investors there is at least one bright spot: The announcement of the new and higher dividend from the old faithful Altria.

Consistently at the end of the month of August, the Board announces the new dividend. As the company has targeted an 80% payout ratio and EPS has been growing at a fairly moderate pace, the range of likely outcomes is not vast. Still, there's always uncertainty around where EPS will land for the year depending on the pandemic, acquisitions gone wrong, FDA action and so forth.

So let's have a look at some of the changes over at Altria lately, as there sure has been more than normal of that this year. In March, the company announced it was finally getting out of JUUL , arguably the worst investment this company has made. Around the same time it announced the intention to buy NJOY, finalizing the agreement in June. It's been obvious to most people that the JUUL track never seemed to work out and so I guess most were a bit relieved that that chapter is behind us. NJOY is a new bet, for sure, but moneywise it's not such a big one so there's a limit to how much damage can be done, and the upside potential is undeniably there in my view. Additionally, Altria will receive a decent $1.7 billion from Philip Morris (PM) related to the IQOS transition agreement. There is therefore very limited net new cash invested in this venture.

On the negative side, one will have to wonder why Altria never got IQOS to work either, as it is such a smashing success for Philip Morris around the world. But when they can't get it to work, it's better to move on and go for a product they have a better chance of succeeding with. The longer term risk of course is what will happen if Philip Morris massively succeeds in the U.S. market as they have around the world. But that is still some years into the future.

In all, it seems like they have taken the necessary steps to get things in order strategically so that they can leave those pesky write-downs behind them and start generating some sustainable decent long-term EPS growth.

Thus far, it seems to be going OK as it managed a 5.4% adjusted diluted EPS growth in Q1 2023 even in the face of some macroeconomic headwinds. The EPS guidance was also reaffirmed and the company expects to deliver an EPS of between $4.98 and $5.13 for a growth rate of 3% to 6% from the $4.84 base in 2022. The mid-range target for 2023 is thus $5.06.

The most concerning point in the report is the continuation of the pretty steep combustible volume declines. For Altria the decline rate was a full 11.0% in Q1 against a 9.0% drop for the industry as a whole. On the positive side, it is a testament to the company's pricing power that it still managed to grow EPS by a respectable 5.4% even with such heavy volume declines. There is therefore some upside to the EPS growth potential if volume declines slow down a bit. In all, the company seems to be on track to deliver around 4-5% EPS growth this year.

Earlier this year, for the first time in as long as I can remember, there was a slight change in the dividend policy of Altria. Instead of sticking to the 80% payout rule, the Board will now target a progressive dividend that targets a mid-single digits dividend growth annually. Not a revolution since EPS growth is expected to be around the mid-single digits anyway, but a change nonetheless. When the Board changes its dividend policy, there is a risk that investors will heighten their expectations somewhat. If we narrow it down, mid-single digits would mean somewhere between 4% and 6%. As the Board has always stuck to whole cents, the question this year is if the raise will be $0.04 or $0.05 per share per quarter for a hike of 4.3% or 5.3%. Though it would be tempting for the Board to offer a full 5.3% increase, given that the increases of the last years have been slightly above 4% and this year is looking OK but not stellar, my prediction is that they would err on the side of caution and go for an increase of $0.04 to $0.98 in the quarterly dividend, representing a percentage-wise increase of 4.3%.

Risk Factors

Regulations, more specifically the FDA, is a major risk for all tobacco companies and Altria is certainly no exception. Last summer the FDA banned the marketing of JUUL, then temporarily lifted the ban a few weeks later. The final outcome and the timing of the nicotine reduction proposal is also marred with uncertainty. Altria is adept at navigating in this landscape due to its many decades of experience, but the risk is ever-present and will not go away. Competition is also a risk, although competition is less fierce in this industry than most other industries due to its concentration of market power. Competitors might chip away at market shares with discount products or with innovative vaping products. IQOS, owned by Philip Morris, has the potential to be a formidable competitor in a few years' time. The long-term decline of smoking rates is an obvious risk to consider before investing in the tobacco space. The recent 11.0% volume decline is much higher than the 3-5% declines we were accustomed to in the days of yesteryear. Price increases can make up for that, but at some point, there is no runway left if almost nobody smokes traditional cigarettes anymore. That increases the need to be successful with other products, such as oral tobacco, vaping and heat-not-burn products.

Current Valuation

Before buying any stock, I like to evaluate its valuation, both on its own and compared to peers. As peers I've chosen British American Tobacco (BTI) and Imperial Brands (IMBBY) as they are the two largest competitors with a U.S. presence.

Source: Seeking Alpha

None of these look expensive on any metric so they can all safely be bought without risking your sleep. What's interesting is that each company wins each its category. Imperial Brands wins the P/S category, British American wins the P/E category with a nice margin and Altria offers the highest dividend yield. Something for everyone here.

There are low expectations priced into these stocks. If investors would demand a 10% long-term return, we can see that it wouldn't take much EPS growth and dividend growth to make that happen. For Altria 1.6% per year would do. Even with macroeconomic headwinds, surpassing that should be doable.

In fact, Wall Street analysts expect this company to deliver 5.2% long-term EPS growth. Assuming the already low P/E multiple stays put, we are looking at expected average annual total returns of 13.6% when we combine EPS growth and the dividend yield. That is comfortably above the long-term returns of the stock market as a whole, and you get it from a stable company that has weathered many storms historically and has proven is ability to deliver consistent EPS growth. It is highly likely to be able to deliver on these low expectations. If it were to surpass them, there is even more upside for investors.

Dividend income investors should have Altria in their portfolios in my view. Investors focused on a combination of high current income and growth compensating for inflation, likewise should own the company. If you're primarily looking for high dividend growth and don't mind a low yield, there are other opportunities that might better fit your needs. For my own sake, Altria will remain a pretty large holding in my retirement portfolio.

Conclusion

Altria has an impressively long dividend growth track record. Over time the growth rate has regrettably come down but it still beats long-term inflation. There have been, and continues to be, headwinds and risks for this company. Luckily for investors, this is fully priced into the stock and the name can be bought for a P/E ratio in the single digits. With modest expected EPS growth and a juicy dividend yield, investors buying Altria today have a high likelihood of beating the market's long-term returns. Altria should be in the portfolio of anyone who covets high current income that will be more than adjusted for inflation over the long term.

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