The market continues to set new highs, which has me even more hesitant to add more capital to an already overvalued market. If you look at the SPDR S&P 500 (SPY) and the Invesco QQQ ETF (QQQ), which are both indexes that represent a good portion of the entire market, the weekly and monthly chart of these indexes show us how extended the overall market is. However, it’s not a stock market but a market of stocks. With this kind of mindset, we can still find diamonds in the rough. There a still a hand full of high-quality stocks that are still consider undervalued in this inflated market. We have discussed a few already, and they still present a good opportunity. In today’s post, we will discuss another undervalued company, Altria Group (MO), with a current dividend yield of 7.24% and has been growing its dividends for over 51 consecutive years making the stock a Dividend King.

Overview of Altria – A Dividend King

 Altria Group, Inc. (MO) is an American corporation and one of the world’s largest producers and marketers of tobacco, cigarettes, and related products. It operates worldwide and is headquartered in unincorporated Henrico County, Virginia. The company’s brands include Marlboro, Copenhagen, Skoal, Black and Mild, IQOS, and several others. Altria recently inked a deal to sell the Ste. Michelle wine brand for $1.2 billion. Altria also has several large investments including a ~$16.7 billion stake in AB InBev (BUD), the global beer company; equity investment in JUUL, the U.S. e-vapor leader; and a 45% stake in Cronos Group, a cannabis company. Altria has a warrant to purchase an additional 10% stakes in Cronos. Today, the Company has a market capitalization of about $88.5 billion and currently trades hands for ~$47.53 per share as of this writing.

Since June 2017, Altria Group has been on a downtrend. In June 2017, the company hit an all-time high, trading for $77.79 per share. Since then, the Company’s stock price has been heading lower while Altria’s dividend yield has been heading higher. When the COVID-19 pandemic hit, the stock price hit a low of $30.95 per share. It has now broken that downward trend and looks to continue to go higher. Below you can see the trend line that Altria has broken on the monthly chart. I will cover the many reasons why this Dividend King, Altria, is an excellent buy at the current market price.

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Altria monthly Chart with Trend Line

Altria Dividend History, Growth, and Yield

We will now look at Altria’s dividend history, growth, and yield. We will then determine if it’s still a good buy at current prices.

Altria has been growing its dividend for 51 years making the stock a Dividend King. In the last 20 years, Altria has an average dividend growth rate of 10.5%. This kind of dividend growth rate beats inflation three to one. Altria’s past 5-year dividend growth average is 9.7%, slightly lower than its ten-year average but not by much. However, in recent years, the Company has slowed down the dividend increases. The last two years of dividend increases have been 3% and 2.4%, respectively. This has a lot to do with the fact that earnings growth also has a slowdown in recent years. We will talk more about earnings growth shortly.  

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Source: Portfolio Insight

So, the dividend growth rate has slowed down compared to its 20-year average. This is concerning as a dividend growth investor. As a dividend growth investor, we would like to see companies continue to grow its dividend faster than inflation. 

Something significant to note is that MO continued to pay its dividend during the most challenging period in the last 100 years. Most businesses and industrials were cutting or suspending their dividends payments; Altria continued to pay out its dividend and increased it. That is very impressive. That tells me everything I need to know about the management focus on the dividend policy and dividend safety. 

The Company has a hefty dividend yield of 7.24% as of this writing. This is an excellent starting yield for those income-driven investors—especially those investors who are leaving the bond market looking for higher yields. Income-driven investors may want a 4.5% yield or higher. So, Altria meets that criteria easily and it not common to have the opportunity to buy a Dividend King with such a high yield.

Altria’s current dividend yield is 97 basis points higher than its own 4-year average dividend yield of 6.27%. I like to look at this metric because it gives me a good idea if a company that I am researching is undervalued or overvalued based on the current yield and 4-year average yield. Price and yield correlate inversely with one another. If the price goes higher, then the yield goes lower. Vice versa as well.

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Source: Seeking Alpha

Is the dividend safe? We should always ask this question if we are looking for an undervalued dividend growth stock to invest in. Sometimes undervalued dividend stocks can present us with a “value trap,” and the stock price can continue to head lower.

This is why it is essential to look at the dividend payout based on earnings and free cash flow (FCF). Analysts predict that Altria will earn $4.60 per share for the Fiscal Year (FY)2021.  Analysts have a 92% accuracy rate in predicting Altria’s futures earnings. Altria is expected to pay out $3.44 per share in dividend for the entire year. Using the dividend payment gives us a payout ratio of 74% based on earnings. Having a 74% dividend coverage with a dividend yield of over 7% gets me very excited. On a Free Cash Flow basis, Altria has a dividend payout ratio of 78%. Thus, the dividend is well covered in both earnings and free cash flow. 

On another note, capital expenditures have been increasing for the past few years. The Company spent $238 million in 2018 and spent $231 million last year. However, in 2016 and 2017, the Company has spent $189 million and $199 million, respectively. This does not concern me because both operating and free cash flow has been growing over the past five years.

Altria Revenue and Earnings Growth / Balance Sheet Strength

This section will look at how well Altria has grown earnings and revenue throughout the years. When evaluating a company, these two metrics are at the top of my list to consider. Without revenue growth, a company can’t have sustainable earnings growth and cannot continue paying out a rising dividend.

For the past ten years, Altria has revenue that has been increasing at a modest Compound Annual Growth Rate (CAGR) of 2.6%. The increase in revenue has to do with price increases on Altria’s products and a few new products. Net income grew at a little better rate of 3.1% over the same ten-year period. 

Earnings, however, have seen a much better growth rate when compared to revenue and net income. EPS has grown 8.8% annually for the past ten years. And over the past five-year, EPS has a CAGR of 9.5%. Reasons like this is why I am not to worry about the slower dividend growth in the past two years. I think that Altria will start increasing its dividend at a higher rate soon.

Last year’s EPS was up from $4.22 per share in 2019 to $4.36 per share for 2020, increasing 3%. Considering the challenging year because of the COVID-19 pandemic, an 3% increase was outstanding. Also, analysts expect Altria to make $4.60 per share for the fiscal year 2021, which would be a 6% increase compared to 2020. 

 Also, the Company has a solid balance sheet. Currently, Altria has a Standard & Poor credit rating of BBB, which is an investment grade. However, the Company does have a very high debt to equity ratio of 10.2. This is very high when I love to see it below 1.5. The high debt to equity ratio is because the Company bought shares of JUUL and is still paying that back. JUUL was an investment on e-cigarettes from Altria. Altria invested $12.8 billion in JUUL in December 2018, acquiring a 35% stake. The investment has not planned out well thus far. It has left Altria with a lot of debt. However, Altria has plenty of free cash flow to continue to strengthen its balance sheet. 

Altria Group Valuation

One of the valuation metrics that I like to look for is the dividend yield compared to the past few years’ histories. I also want to look for a lower P/E based on the past 5-year or 10-year average. Furthermore, I like to use the Dividend Discount Model (DDM). I use a DDM analysis because a business is ultimately equal to the sum of all the future cash flow that that business can provide. 

 Let’s first look at the P/E ratio. Altria has a P/E ratio of 10.4 based on Fiscal Year (FY) 2021 earnings of $4.60 per share. The P/E multiple very low compared to the past 5-year P/E ratio average of 15. If Altria were to revert back to a P/E ratio of 15, we would obtain a price of $69 per share.

Now let’s look at the dividend yield. Like I mentioned, the dividend yield currently is 7.24%. Looking at Altria’s trailing 5-year dividend yield average of 5.66 %, there is a huge potential upside. For example, if Altria were to return to its dividend yield 5-year average, the price target would be $81.27.

The last item I like to look at to determine a fair price is the DDM analysis. I factored in a 9% discount rate and a long-term dividend growth rate of 5%. I use a 9% discount rate because of the high current dividend yield. The projected dividend growth rate is lower than its 10-year average but higher than the most recent increase. This gives us a fair price target of $71.55 per share.

If we average the three fair price targets of $69, $81.27, and $71.55, we obtain a reasonable, fair price of $73.94 per share. This gives Altria a possible upside of 55.6% from the current price of $47.53.

Conclusion on Altria – A Dividend King to Own

Altria Group is a high-margin business with durable brand competitive advantages. While there’s a decline in its cigarettes market, that market remains high in free cash flow. But Altria is a Dividend King. With a 7% yield, more than 50 consecutive years of dividend raises, a reasonable payout ratio, and the potential that shares at 55.6% undervalued, this is an excellent idea for dividend growth investors seeking yield.