Why I Bought Altria, Again

My most old and familiar holding is Philip Morris. Altria (MO) is the US version and Philip Morris International (PMI) is the international version. They are the famous makers of the Marlboro brand.

In a way these two companies are the simplest businesses to understand. They spit out copious amounts of cash. And the majority of the cash goes to the government coffers. At the same time these governments want to ostensibly regulate the tobacco industry out of business. And finally, people are generally smoking less than before. Today in the US only 16% of the population smoke and the per capita consumption is 1/4 the number at the peak in 1960.

First, I'll discuss Altria. In the US the best selling cigarette by far is Marlboro. It is 43% of the market!

	MO
Price	$39.1
Marketcap (M)	$72726
PE	2019: (loss) 2018: 10.49
Div Yield (%)	8.18

In my table, I have omitted the equity metrics because they have negative tangible book value. That is not to say that these companies are not valuable. It is just that their value is almost entirely in their brand. Moreover, these companies have enormous debt that is more than tangible assets they have. So their investment utility is solely based on their dividends. And they are very generous with dividends. Their pay ratios approach 100%. But everyone knows the future looks bleak for tobacco. But this has been the case for more than 20 years. In the last 10 years after Altria and PMI split into two companies, Altria has increased dividends at a 9.5% rate! And today it yields 8.2%. Somehow Altria has managed to increase profits when cigarette sales have steadily declined consistently. Just last year US cigarette volume decreased 5.5%.

Because of Altria's simplicity, we can deduce its value simply from its cash flow to shareholders. Imagine this plausible situation. Tobacco consumption and regulation will drive companies like Altria to bankruptcy in 30 years. But right now it is doing ok, and say it continues to pay generous dividends and grow at 9.5% as the recent past for the next five years. Then growth will taper. So for simplicity say dividend growth becomes zero for five years. And after that the dividend falls until zero 20 years later. So what I described can be shown by the following chart. The return from just the dividends is 8.3%!

Evaluating Altria using discounted cash flow (DCF) analysis would require the cash return in this scenario to be greater than the risk-free return plus the risk premium. In my analysis, I'd like to replace the risk-free rate with the cost to borrow money to buy the stock. In today's low interest environment, this can be as low as 2%. And a common risk premium is 6%. So therefore, I have a 8% hurdle for this investment, which Altria just passed. And this is a very negative case scenario. So Altria's cash flow can be worth the price today.

So putting the worse case aside, there are positive factors in Altria's future. Cigarette consumption has declined consistently, but I think there is a limit. Society has clamped down on minors smoking and smoking in public places. But for the hard-core smokers, nothing will deter them. And taxation is already 45% of the current cigarette price. It is primarily a business for the government! It is not in the government's interest to kill cigarettes. This also means that companies like Altria have big hidden pricing power. Altria gets less than 20% of each cigarette sold, so when it increases the selling price by 10% the consumer only feels a 2% increase.

Also, some of the decline is due to the switch to new and old alternative products such as e-cigarettes, smokeless tobacco and marijuana. It is easy to see the appeal of a nicotine fix without the social stigma. And marijuana does less damage to health than tobacco products.

Altria, has dabbled in all these areas. Altria is the leading US supplier of smokeless tobacco products such as Copenhagen. They bought a $13 B stake in JUUL Labs, a e-cigarette maker. However, this deal was a disaster for the Altria and the company has written off 2/3 of the investment. And finally, the company has also tried to invest in marijuana through its 45% ownership of Cronos, a Canadian cannabis company. That hasn't worked out well either as Cronos stock has dropped by 2/3 also!

Aside for tobacco and marijuana, Altria is also big into their sin companion: alcohol. Altria owns a small wine maker, and most importantly, a 10% stake in Anheuser-Busch InBev, which is worth $18B.

The human race may get more and more health conscious, on average, but I think there will always be a place for sin. We are living better and longer, then we should also live it up more! So, over the long term, I think that Altria may very well be able to hit on a killer product that will replace cigarettes, if and when cigarettes are regulated to oblivion.

All these factors support my view that Altria and other tobacco companies are underestimated companies with a large margin of safety and are well worth the risk to invest. They are the quintessential value stocks.