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Altria (NYSE:MO) Its dividend yield has suddenly jumped toward 9%, as a confluence of headwinds has affected the stock. Apart from the inflationary risk that is affecting the entire market, MO is facing both regulatory intervention in nicotine as well as a ban on JUUL products. The company has historically increased both earnings and dividends, making the 8.6% yield potentially attractive. I discuss why the future is more fuzzy than it looks, the stock isn’t as slam dunk as it might seem.
MO stock price
It’s been almost as many years since the stock is down 50% from 5 years ago.
Data by YCharts
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The last time I wrote about MO was when I called it a value trap. The stock is down 22% since then, providing an even higher yield. Unfortunately, the valuation is still not high enough to change my view that it remains a price trap over the long term.
MO Stock Key Metrics
MO’s latest quarter was pretty typical for the company, with steady revenue and single-digit EPS growth.
2022 Q1 Presentation
Cigarettes isn’t a secular growth story, but MO has shown that solid fundamentals don’t need to be generated. MO saw its smokeable segment deteriorate at a single-digit pace in the quarter (by volume).
2022 Q1 Presentation
MO was able to offset the decline by increasing prices and realizing operating efficiencies, as evidenced by the 5.7% gain in operating income.
2022 Q1 Presentation
While MO has other operating segments, smokeable products still make up 85% of total operating income.
MO returned $2.2 billion to shareholders in the quarter through dividends and share repurchases.
2022 Q1 Presentation
MO ended the quarter with $23.5 billion in net debt versus $22.5 billion at the end of 2021.
What should investors know about Altria’s dividend?
The stock is giving an 8.7% return, raising fears of a dividend cut.
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On the surface, MO’s dividend appears to be safe. MO has a fair payout ratio and a history of dividend growth.
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Is Altria a Dividend King?
With respect to that history, MO has increased its dividend for 18 consecutive years. While that means it’s not technically a “dividend king,” requiring 50 consecutive years of dividend growth, MOs have steadily increased their dividend payouts over the past several decades.
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Is Altria a good long term investment?
Unfortunately, past results will play a minor role in determining future results. I continue to predict that trouble is only 5-10 years away. There are already signs of negative catalysts emerging. First, the FDA has officially withdrawn authorization for JUUL products — MO previously invested nearly $13 billion in the company in 2018. Certainly, I have seen the argument that unavoidable losses are non-cash charges and will not directly affect operating cash flow. However, e-cigarettes were considered the new growth frontier for the company – the detriment of that growth thesis is likely to put a cap on the potential for multiple expansions.
Next, the FDA is trying to reduce the nicotine in cigarettes to non-addictive levels. Smokeable products have already seen a secular decline in shipment volumes over the years – I expect this to accelerate when product addiction subsides. The key here is the long-term thesis. Video is streamable. E-commerce is inevitable. I consider the decline of cigarette smoking to be inevitable.
Should MO Stock A Buy, Sell or Hold?
Let us now discuss how the long-term thesis factors in with evaluation. MO is trading at 8.7% yield and 8.5x projected 2022 earnings. The stock has traditionally traded at 12.4x forward earnings, suggesting it traded at a historical discount.
But the risk-reward proposition of any investment should always be considered. MO is a company that isn’t anticipated to grow its topline much.
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One can dream of achieving both a high dividend yield and high yield and capital appreciation, but how realistic is this assessment? The decline of smokeable products poses real secular risks to MOs. The company has been able to offset the decline in shipment volumes with increase in prices and operational efficiencies. However, the decline in shipment volumes looks like a secular headwind, while price increases and operational efficiencies can only go so far. I believe there is a certain price at which products become unattractive to the general market – not to mention the ongoing price competition from competitors. I suspect the average investor’s view that cigarette volume will accelerate and become a secular growth story. My point is that the upside here is limited due to secular adversities and not least negative sentiments. The current 8.7% yield doesn’t seem so unreasonable. Perhaps one might think that the stock could trade for yields of up to 7%, which is roughly 20% above capital appreciation.
On the other hand, the downside should not be underestimated. MO has a large leverage load on debt of approximately 2x EBITDA which drives much of the bearish thesis. Sure, the stock clearly isn’t expensive at 8.5x earnings, but if the company starts to show a secular decline in earnings, I expect it to aggressively start paying down debt. The dividend payout ratio is less than 75%, but that doesn’t mean earnings can drop by 25% without a dividend deduction. In the event of a secular decline in earnings, the MO will need to maintain or reduce its leverage ratio because otherwise it may be unable to refinance the maturing loan at comparable interest rates. My estimate is that earnings only need to decline by 6% before any additional income above dividends can be fully redirected toward debt payments.
Any recession scenario may not be immediate – it is predicted that no nicotine reduction policies will be in place until 2024. But my point is that the upside potential is limited around market returns, as the stock can generate around 10%. 11% annualized return between its dividend yield, growth and multiple expansions. But as more years pass, it may get closer to the “tipping point” discussed above, where operating income outweighs the secular decline. At that point, one shouldn’t underestimate the possibility that the stock trades at 5x earnings or less — which would be enough to wipe out many years of shareholder returns and almost certainly ensure that the stock Will not outperform or even match the market. over the long term. I fear that many dividend investors may mistake MOs for being a “safe” stock, but that assessment may be disproportionately affected by past financial trends without sufficient consideration for the long-term outlook. I continue to recommend avoiding the stock, even though the high dividend yield outweighs the possibility of a near-term upside.
