Despite the coronavirus crisis, the S&P 500 has rallied 27% in the last 12 months, to new all-time highs. Consequently, income-oriented investors are struggling to identify stocks with attractive and safe dividend yields. In addition, many high-yield stocks carry the risk of a dividend cut upon the next downturn. Altria (MO) is a bright exception, as it is a top retirement stock, with a 7.6% dividend and a material margin of safety.

Image Source: Pixabay

Business overview

Altria sells cigarettes, chewing tobacco, cigars, e-cigarettes, and wine under the Marlboro, Skoal, Copenhagen, and St. Michelle brands, among others.  The company has also tried to diversify away from its flagship tobacco products and thus it has a 10% equity stake in Anheuser-Busch InBev (BUD), a 35% stake in e-cigarette maker JUUL, and a 45% stake in the marijuana company Cronos Group (CRON). Nevertheless, Altria still generates the vast majority of its revenues and earnings from its smokeable tobacco products.

In the last few years, the flagship business of Altria has been facing intense competition from e-cigarettes. In an effort to defend its business, Altria acquired a 35% stake in the leader of this market, JUUL. However, the tobacco giant overpaid for that stake, as the transaction took place near the peak of the euphoria over the prospects of JUUL. Since then, the regulatory authorities have significantly restricted the marketing and expansion efforts of JUUL and thus they have limited its growth potential. As a result, Altria wrote off $4.1 billion off its stake in JUUL, less than two years after its acquisition of the stake.

On the bright side, Altria has managed to remain in its multi-decade growth trajectory despite the heating competition in its business. In 2020, the company grew its revenue 4.2% and its earnings per share 3.6% over the prior year. Moreover, it expects to grow its earnings per share 3%-6% this year.

Growth prospects

Altria has always faced a negative secular trend, namely the slowly decreasing portion of the U.S. population that smokes. However, this headwind has not prevented the tobacco giant from growing its bottom line. Thanks to the inelastic demand for its products, Altria has consistently raised the prices of its products year after year and thus it has grown its earnings per share every single year for more than a decade. Over the last decade, it has grown its earnings per share at an impressive (for a mature company) 11.5% average annual rate.

Altria has somewhat decelerated in recent years thanks to the growing popularity of e-cigarettes and other products. However, the company has invested heavily in alternative products, via its 35% stake in JUUL and its $1.8 billion investment in Cronos. It is also trying to expand the reach of its own e-cigarette brand IQOS. All these are likely to be significant growth drivers in the upcoming years. Nevertheless, due to the deceleration of Altria in recent years and the transitional phase of this business, it is prudent to expect Altria to grow at a slower pace than its historical growth pace. We expect Altria to grow its earnings per share by approximately 2.4% per year on average over the next five years.

Competitive advantages

The most important competitive advantage of tobacco companies, including Altria, is the inelastic demand for their products. Altria has an additional competitive advantage, namely the unmatched strength of its flagship brand, Marlboro, whose market share has remained above 40% for several years. Thanks to the strength of its brand, Altria has been able to raise the price of its products year after year without hurting its market share.

Another competitive advantage of Altria is its rock-solid business model, which requires minimal investments. Thanks to the extremely low capital expenses required in this business, nearly all the operating cash flows end up being free cash flows. This is the reason behind the reputation of tobacco stocks as being extremely shareholder-friendly.

Dividend

Thanks to its consistent earnings growth and its excessive free cash flows, Altria has raised its dividend for 50 consecutive years. This is by far the longest dividend growth streak in the tobacco industry and places Altria in the group of Dividend Kings.

Due to the aforementioned headwinds, the stock of Altria has underperformed the broad market by a wide margin in recent years and hence the stock is currently offering an exceptionally high dividend yield of 7.6%. In most cases, such a high yield usually signals that a dividend cut may be just around the corner but this is not the case for Altria. The stock has a payout ratio of 78% and has kept growing its earnings per share despite the heating competition. The company has increased its debt load due to its recent investments but it is now in the process of using its excess cash flows to reduce its debt load. Overall, Altria is not likely to cut its dividend anytime soon. The company’s secure high yield should appeal to investors looking to live off dividends.

Final thoughts

Due to heating competition in its flagship business, Altria has dramatically underperformed the S&P 500 in the last five years, as the stock has shed 28% whereas the S&P 500 has rallied 91%. As a result, Altria has fallen out of favor in the investing community. However, this underperformance has presented a rare investment opportunity for income-oriented investors, who can lock in the 7.6% dividend yield of the stock and rest assured that the dividend will continue growing for years.