In my initiating report on Altria (MO) last November, I had initiated the discussion on MO's long term positive outlook, attractive dividend yield, strong moat, and stable EPS growth and recommended a buy with a target price of $51. The stock, having topped the $51 mark post the publication of the report, is currently reeling at $30-levels amidst the global sell-off on the back of Coronavirus pandemic. In this report, we would take a detailed look at the near term challenges, COVID-19 impact and the outlook going forward.

4Q Review and Guidance

Shipment volumes for smokeable products declined 6% in Q4 2019 and 7% in 2019 against the market volume degrowth of 4.5% and 5.5% respectively, in line with the expectations. The company continues to be on a wobbly trajectory in the near term with volatile cigarette volumes compared to historical stable EPS growth in mid to high-single digits. The management reiterated their focus on IQOS and on! products having being rolled out across several parts in the US, which has seen a staggering growth for MO's partner PM outside of the US. According to Philip Morris International, the total users using IQOS has jumped up to 13.6mn from 7.6 mn in two years, with 71% users who have stopped smoking and switched primarily to IQOS. IQOS also is currently the third-largest brand in the tobacco market globally with a 5.5% market share, even though it hasn't been fully rolled out across its 52 markets.

The disappointing part continues to be JUUL where it recorded an additional $4.1bn impairment in Q4 topping the earlier $4.5bn impairment charges already recorded earlier in the year.  The legal cases pending against JUUL rocketed up 80% since October and the company doesn't expect to make a dime out of it at least until three years resulting in a sharp markdown as well as a decrease in earnings guidance 4-6% EPS growth for 2020-2022 vs (5-7% three months back). The company increased its dividend 54^th time in the 50 years with an annual dividend yield of 9.8%, one of the best across the S&P 500 stocks.

Core Business Outlook

The tobacco industry's historically reliable and stable growth has been strained over the last two years, primarily due to declining cigarette volumes due to rapid e-cigarette adoption. However, a fall in retail gas prices could lead to an uplift in cigarette volumes as seen historically. Given that almost 75% of cigarettes are purchased at convenience stores, which are primarily located at gas stations, a lower gas bill typically leads to a higher spend on cigarettes. This was particularly evident when the gas prices fell ~27%/ 13% YoY in 2015/2016 which led to a cigarette volume decline of 0.5% and 2.5% in the corresponding period. Current futures point a 23% decline in oil prices which could entail a volume uplift if the current prices remain stable.

Coronavirus Pandemic

The US has been one of the worst-hit in the current coronavirus pandemic recording over 130,000 cases across the country and the highest globally. Also, MO's Chairman and CEO, Howard Willard, took a temporary leave having contracted the virus, thereby vacating the post for the top job to its CFO, William Gifford. MO also closed down its sole manufacturing facility in Virginia for two weeks after reports of its second employee having tested positive. The company also closed down its Middleton facility due to supply-chain related issues for two weeks, however, the management maintained that they are sitting on an adequate inventory of ~2 months in Virginia facility and ~3 months in Middleton to cause any meaningful disruption in supply. The benefit of lower gas prices could well be offset by less travel, fewer social events and a probable shift towards a healthy lifestyle away from cigarettes. However, given the addictiveness of the product, the demand for cigarettes should largely be resilient and expect consumers to stockpile in the wake of current quarantine. 

Valuation

We continue to value using DCF assuming a normalized top-line growth of -1% and 0% EBIT margin. We continue to assume a WACC of 7.5% and a terminal growth rate of -1%. Our target price includes carrying value for its equity stake in ABI as of December 31, 2019, investment in CRON (at 50% haircut to its current market value) and for its JUUL investment (at about a third of its value currently).

Conclusion

While the near term story continues to be bogged down due to coronavirus pandemic and factory shutdowns along with a grim outlook on its core business, investors should be looking to enter at current levels for a defensive stock during the times of current volatility providing attractive dividend yield with stable EPS growth. Reiterate at Buy.