2023-04-14 06:13:33 ET
Summary
- Altria Group has struggled to grow sales in recent years due to a decline in smoking rates, but its bottom line results have been strong.
- Investors have shares priced cheaply because of concerns about the company's future.
- But management is well aware of this and is focusing on transforming the company into something else entirely.
I'm not a smoker personally, but I do have a tremendous number of smokers on both sides of my family. It's amazing that a product meant to kill you has been able to grow into such a massive business opportunity for companies and investors alike. And in this space, one business that deserves special attention is industry leader Altria Group ( MO ). Recently, financial performance achieved by the company has been rather mixed. Revenue has been a bit lumpy, and the same can be said of profitability. But from a cash flow perspective, the general trend has been quite positive. For an industry leader that is doing so well, you would expect a rather lofty share price. However, shares actually look cheap at this moment. Some may attribute this to concerns over a continued decline in smoking. However, Altria Group is a far larger, more diverse, and more ambitious company than what you might think. Although smoking rates are dropping, the company continues to innovate and make interesting investments. Given all of these factors, and focusing solely on the business side of things instead of anything else, I've decided to rate the enterprise a 'buy' at this time.
A look at market conditions
At its core, Altria Group describes itself as a business that owns a leading portfolio of tobacco products that caters to US consumers. The company focuses on a variety of offerings in this category. For instance, in 2022 , the business sold 84.7 billion units of cigarettes. It also sold 1.7 billion units of cigars. Other offerings include oral tobacco products such as Copenhagen, Skoal, and Red Seal, as well as oral nicotine pouches such as its on! brand that boasts a 24% market share in the US nicotine pouch category.
Through a special agreement that it has with Philip Morris International ( PM ), Altria Group also has the exclusive right to commercialize some of that company's heated tobacco products, with many of those activities occurring through its Philip Morris USA subsidiary. Though the IQOS System that the company has been commercializing since 2019 is slated to be assigned to Philip Morris International next year. The most famous of the company's brands has got to be Marlboro. In fact, based on the data provided, that brand alone has a roughly 52.8% market share in the premium tobacco space. It also has a 42.5% stake of the broader cigarette market, with the next 11 largest competitors combined holding a stake of only 41.9%.
Due to a combination of factors, including continued public outreach regarding the harmful effects that tobacco has, a rise in the adoption and legalization of cannabis, and other factors, have played a big role in reducing cigarette smoking rates. From 2001 through 2022, we have seen the share of those aged 65 or older who smoke drop from 14% to 8%. For those 50 to 64 years old, the drop has been from 23% to 18%. For those aged 30 to 49, the decline has been from 28% to 17%. But the most impressive it comes from those aged 18 to 29. Over the same window of time, we have seen this number drop from 35% down to only 12%. As the population has become more educated, the rate of smoking has dropped as well. Over the window of time shown, the percentage of those aged 18 to 29 who smoked and who did not graduate college declined from 39% to 14%. And for those who did graduate college, it has fallen from 17% to 7%.
Given these trends, and Altria Group's US-centric business model, it might be a surprise to learn that revenue for the company has been virtually flat for the past five years. Sales have bounced around between a low of $25.10 billion and a high of $26.15 billion, with no clear trend from year to year. The biggest shift from any one year to the next came from 2021 to 2022. Revenue here dropped from $26.01 billion to $25.10 billion. This was driven by a plunge in total smokeable products from 95.6 billion units to 86.4 billion. Management attributed this drop to both a continued industry decline rate, which I already covered, and reduced buying because of economic effects on consumers' disposable income.
Even though sales have been more or less flat, profitability for the business has been encouraging. If we ignore net income because of the wide variations we have seen from year to year and focus, instead, on cash flow. Things start to look rather positive. Operating cash flow, as the chart above illustrates, has also been a bit lumpy. But if we adjust for changes in working capital, we would have seen a consistent increase over the past five years, with the metric rising from $7.32 billion to $8.84 billion. Over that same window of time, EBITDA showed a similar trend, with the metric rising from $10.06 billion to $12.53 billion.
This significant profitability has allowed the company to continue rewarding shareholders in the form of dividends and share buybacks. Over the past five years, for instance, management allocated $6.02 billion toward buying back stock. But this pales in comparison to the $30.82 billion of dividends sent to shareholders. What's more, the dividend has only increased over this window of time. Last year, for instance, the company allocated $6.60 billion toward distributions. That's up from $5.42 billion reported in 2018. Even though we are seeing a long-term decline in smoking rates, I would argue that the distribution that the company is paying out is very stable at this time. Even though the yield on the business is already a lofty 8.3%, the company could increase this number if it so desired. After all, using data from 2022, the firm allocated just 74.6% of its adjusted operating cash flows to rewarding shareholders in the form of distributions.
Those who are bearish about the company would point out that, if current trends persist, the company must eventually experience pain from a decline in the number of smokers. The good news for shareholders is that management is well aware of this and they are investing heavily in alternatives that they believe will create value for the enterprise. Earlier in this article, I already mentioned the on! nicotine pouches. In the fourth quarter of 2022 alone, the company was responsible for selling 22 million cans of this product. That was up from 15 million experienced the same time last year.
There are, of course, other offerings that the company has pushed. In fact, the company has an entire initiative aimed at a smokeless future. This includes alternatives like heated tobacco. Through a partnership that has with JT Group, the company is pushing the sale of a heated tobacco device called PLOOMX. Its own heated tobacco capsule product, called SWIC, allows users to inhale a puff of the product. One of the more interesting initiatives pushed by the company is in the vaping market. In order to move more fully in this direction, the company announced, earlier this year, the acquisition by it of NJOY Holdings, which produces a wide array of vapor products that have received market authorizations from the FDA. That particular purchase cost the company $2.75 billion, plus there could be another $500 million in contingency payments over the next few years.
This further pushes the company into a roughly $7 billion space in the US retail category, catering to 14 million US adult tobacco consumers, with 9.5 million exclusively utilizing vapors. In fact, this nascent industry already accounts for roughly 15% of tobacco volumes in this country, and about 50% of total smoke-free tobacco volumes.
Using data from 2022, I would make the case that shares of the company are very cheap from a cash flow perspective. The price-to-earnings multiple of the company comes in at 13.9. The price to adjusted operating cash flow multiple is even lower at 9.1, while the EV to EBITDA multiple of the firm should be about 8.2. For context, I also provided valuations based on data from 2020 and 2021. These can be seen in the chart above. As part of my analysis, I also compared Altria Group to three similar firms. On a price-to-earnings basis, two of the three firms were cheaper than our target. But when it comes to the other valuation metrics, which would be the price to operating cash flow metric, and the EV to EBITDA metric, we can see that only one of the firms was cheaper than our prospect.
Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
Altria Group | 13.9 | 9.1 | 8.2 |
Philip Morris International | 17.0 | 14.2 | 14.4 |
British American Tobacco ( BTI ) | 10.1 | N/A | 8.7 |
Imperial Brands ( OTCQX:IMBBY ) | 10.9 | 5.8 | 6.8 |
Takeaway
From all that I can see, Altria Group is a solid company at this time. In the long run, the firm does have a lot to worry about from a continued decline in smoking. However, management is keenly aware of this and they are making big steps to combat it. Although revenue has been stuck in a fairly narrow range and net profits have been all over the map, actual cash flow data has largely improved over the prior few years. This, combined with the high yield and the low share price, leads me to feel as though the company is a solid 'buy' candidate at this time.
For further details see:
Altria Group: Cheap And Transformative