BTAFF - Should You Buy 8.2%-Yielding Altria Ahead Of A Recession?

Summary

• During times of market volatility, it's good to take a step back and search for stability.
• The tobacco industry is generally seen as a declining industry. However, this isn't actually the case.
• We believe Altria's valuation and dividend yield adequately compensate investors for the regulation risks the company may face.

Currently, there is plenty of market volatility as the economy looks poised to enter a recession . During times like these, it's good to take a step back and search for stability. Altria Group ( MO ) is an all-weather company that can be relied upon for steady dividends, and it's trading at an attractive valuation. As a result, we are bullish on Altria for 2023.

Tobacco Industry Snapshot and Growth Catalysts

The tobacco industry is generally seen as a declining industry. However, this isn't actually the case. Indeed, the tobacco market is expected to grow at a CAGR of 3.75% from 2022 to 2027 globally, with Asia Pacific representing the fastest-growing market. Developing economies are the main growth drivers because of their lenient rules surrounding tobacco products, which allows these economies to generate a significant portion of their tax revenues.

In addition, tobacco products remain very addictive, and users will continue to spend money on them. Whether it be inflation or recession, consumers will likely reduce spending elsewhere before considering cutting back on tobacco consumption. Not only that, tobacco consumers are significantly more likely to stick with their preferred brand no matter the price compared to other types of products:

In addition, the fact that the industry as a whole is viewed as declining and limited in upside due to government regulations limits the number of new entrants into the market. Not many young and bright entrepreneurs would be excited by the idea of taking on industry giants for what they perceive to be a shrinking pie.

As a result, tobacco companies have significant pricing power that allows them to continue increasing their profits and dividends.

Competitor Analysis

Let's take a look at how Altria compares to some of its competitors.

Starting with gross profit margins, Altria's comes in at 67.7%, slightly higher than Philip Morris' ( PM ) 65.9% but well below that of British American Tobacco ( BTI ) at 82.5%. However, when looking at its operating margin, Altria does a much better job of controlling operating expenses. Indeed, it has an operating margin of 59%, whereas the competitors listed here range between 38.3% to 41.3%.

Its dividend yield of 8.2% is undoubtedly juicy and above that of its peers. BTI has the closest yield at 7.7%, while Vector Group ( VGR ) and PM come in at 6.4% and 5%, respectively. Now, this is likely because Altria isn't the fastest-growing company out of the bunch, and investors might be worried about its decline in sales last quarter when compared to the prior year. Nevertheless, the firm has been growing its sales overall in the past five years at a CAGR of 1.8%. It's also worth noting that total sales were impacted by its wine divestiture.

In addition, we believe its free cash flow growth is what investors should be focusing on the most. Over the past five years, it managed to increase FCF by a CAGR of 17.8%. This demonstrates that Altria, and also its competitors, are finding ways of improving their operating efficiencies as all of them demonstrate free cash flow growth that outpaces revenue growth.

Is Altria Stock Undervalued?

Valuing Altria stock is relatively simple. It has stable dividends that analysts expect to grow at a CAGR of around 5% over the next three years. This type of growth rate could possibly be sustained over the long run but will most likely fall closer to 2%-3% in the long run.

Nevertheless, in order to demonstrate the amount of value present in the stock and also to account for potential risks associated with future regulations, we will use a simple single-stage dividend discount model with a 2.5% perpetual growth rate. Using a discount rate of 9.1%, the calculation is as follows:

Fair Value = Dividend per share / (Discount Rate - Terminal Growth)$55.76 = $3.68 / (0.091 - 0.025)

As a result, we believe that Altria is worth at least $55.76 per share under the current market environment.

Risks Associated With Altria

No company is without risk, and investing in Altria does carry quite a bit of regulation risk. Indeed, that's the main reason why its stock has such a juicy yield. It's worth noting that the firm's risk disclosures for the Legal & Regulatory category are actually higher than that of the sector average:

The company includes its investment in Juul as a legal liability, warning investors that it may be forced to divest from the business or rescind the transaction.

In addition, global supply-chain issues might cause problems, as they have with almost all companies that sell physical products. However, we believe Altria's valuation and dividend yield adequately compensate investors for these risks.

Final Thoughts

Altria is definitely a solid business with stable and predictable dividend payments that are useful during periods of market volatility and macroeconomic uncertainties. As a result, we believe Altria stock is a solid addition to the portfolios of income-oriented investors or those who are looking to balance out their more speculative bets.

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