Altria, the electric (r)evolution
February 8, 2019
SHARE PRICE: $48,72
MARKET CAP: $91,55B
1. INTRODUCTION
After almost 20 years of heavy smoking, I decided to quit. This was a year ago and it was something I had been wanting to do for a long time.
It wasn’t as hard as I imagined it to be. Surprisingly enough, after the first couple of days, it was easy, liberator. I was finally free! Even today I smile when I think about it. I am proud of myself.
Having known Marlboro cigarettes so well, I decided to take a look at the company that makes them. I remember buying them everyday, smoking them every hour, and I continued to do it year after year despite constant increases in price.
This is the stickiest product I have ever seen. I suspect this company might have tremendous economics, so lets start by going to their website.
2. BUSINESS OVERVIEW
2.1. BUSINESS DESCRIPTION
First of all I feel I should explain what exactly is the difference between Altria Group and Philip Morris International (PMI) since I had this doubt myself and I guess most people outside of the U.S. might have it too. (If you already know it, you can skip this part)
Prior to 2003 there was this huge conglomerate called Philip Morris Companies Inc. which in 2003 changed its name to Altria Group in an attempt to improve its image and steer away from the negative connotations associated with tobacco.
In 2008 Altria spun-off its international tobacco operations to limit legal liabilities, so Philip Morris International (PMI) became a whole new company completely independent from Altria.
They also owned Miller Brewing and had a 84% stake in the giant packaged food company Kraft which they spun off in 2007. In 2002 Miller was sold to SAB, and in 2016 the new SAB Miller was merged with AB InBev leaving Altria with a share of 10,2% on the giant brewer.
After this short story of huge spin-offs, what you need to bear in mind is that Altria’s main business is the manufacturing and sale of cigarettes in th Unites States while Philip Morris International operates in the rest of the world. They are like twin sisters. There are even rumors of a merger between the two.
2.2. LARGEST SHAREHOLDERS
The largest shareholders are the usual suspects. Vanguard, BlackRock and some others.
2.3. MANAGEMENT TEAM
I’m going to Google the CEO……. Ok, Howard has been in the company for 26 years now, so he knows is way around.
3. HISTORICAL CONTEXT
3.1. LONG TERM CHART
The stock price is now $48,72, down from historical high of $77,28 in 2017, which means Mr. Market is not that bullish on Altria anymore.
3.2. MARKET CAP AND SHARES OUTSTANDING
At first glance it’s kind of strange to see these wild variations in Market Cap while the number of shares outstanding is smoothly decreasing.
But the reasons for such wild swings were the Spin-Offs of both SAB Miller in 2007 and Philip Morris International in 2008.
3.3. SALES - OPERATING INCOME - OPERATING MARGIN
Before we go any further I want you to look at this chart and take into consideration that the percentage of U.S. adult smokers has been in constant decline since the fifties!!!!
Now back to Altria. Despite the decline on the demand side, sales have been growing at a 2,1% annual rate for the past 10 years.
One of the greatest achievements of Altria has been the ability to grow its margins while its target audience declined. Operating margin has been almost constantly on the rise, hitting the 46% mark in 2018.
Quite an amazing feat, let me tell you!
Note: Sales figures are already discounting excise taxes.
We can clearly see the impact that the big spin-offs had when sales came down from $69 Billion in 2005 to $15 Billion in 2007, but it’s clear the (slow) rise in revenue ever since.
3.4. SALES BY SEGMENT
Now, the company tells us that they are selling fewer cigarettes each year that passes. They sold 110 billion cigarettes last year, 16 billion less than 4 years ago.
So how does this compare to their revenue? Surely sales have been declining.
Hard as it may seem, revenue from smokeable products as been growing year over year. And this has been the reality for decades.
Altria is constantly and successfully raising prices in order to offset the decline in the number of cigarettes sold.
I can clearly remember paying more and more every year for a pack of cigarettes and I just didn’t care. I would say to myself “I’ll just save on other things, but not on this one”.
3.5. MARLBORO MARKET SHARE
Usually a company lowers prices in order to gain market share, so when I saw the chart below I was astonished. Altria has been able to gain market share year after year for over 5 decades while at the same time raising the price of its products.
Unfortunately, in recent years Altria hasn’t been able to accomplish similar results.
In 2017 the market share for Marlboro cigarettes was down to 43,4% and in 2018 it declined to 43,1%.
3.6. NET INCOME, NET MARGIN
As expected, profits took a big hit after the spin-offs, but they’ve been rising ever since. In 2018, net income was just shy of $7B, representing a net margin of 35%!
3.7. SEASONALITY
There is no seasonality to Altria’s sales as smokers couldn’t care less on which season they are.
3.8. DIVIDENDS
Dividends were $3,2 per share in 2018 which equates to a great 6,57% dividend yield.
3.9. PROFITABILITY RATIOS
Altria has high return on equity (49%) and average return on assets (13%).
3.10. FINANCIAL RATIOS
Current ratio has been falling for the last 10 years and it’s now 0,6. The Debt to Equity ratio was in pretty rough shape in recent years, then it went down to acceptable levels in 2016 and 2017, but is now coming back up again to 1.7, because Altria raise more debt to finance the Juul acquisition (more on that later). Altria’s Net Debt/EBITDA is 2.3 which is not a good level to be at, but it isn’t a disastrous one either.
3.11. PRICE TO EARNINGS RATIO
The forward 2019 PE ratio is 12, which is lower than the historical average of 14, implying that Mr. Market isn’t that bullish on Altria.
3.12. RISKS AND COMPETITION
Regulatory: FDA is planning on a proposal to ban the sale of menthol cigarettes in the U.S. With menthol cigarettes representing 20% of total revenue, and a minimum 2 year time-frame for that ban to be put in place, Altria must be able to offset that decline with some other product.
Taxes: Excise taxes are a big part of what consumers pay and there is no way to foresee what these will be in future years.
Poor execution related to new acquisitions and segments.
3.13. TYPE OF PLAY
With a 6,57% dividend yield, Altria is a dividend play.
4. OVERVIEW AND CONCLUSION
4.1. OVERVIEW
In the world of cigarette addiction, smokers are extremely loyal to their preferred brand. Maybe sometimes they try other brands, or even some variations within the same brand, but we can safely say that once you’ve decided for a specific brand, it’s very hard to switch.
Although Altria has seen constant decline in the number of cigarettes sold for decades, it has always been able to increase EPS, be that by raising prices, share buybacks, acquisitions or its stake in other companies like Ab Inbev.
I have no doubt Altria will be able to find interesting sources of growth like these 3 bellow:
iQOS: The iQOS is the new great source of growth for Philip Morris International and after Altria gets clearance from the FDA to sell it in the U.S, it will be one of its next great drivers of growth.
The iQOS is a tobacco heating device where you insert a “mini cigarette” called Heets and heat it up almost to the temperature of combustion but without burning it. I’ve smoked iQOS throughout my last year of smoking and I must confess that I loved it. I now see almost everyone around me switching from regular cigarettes to the iQOS.
Juul Labs: Altria bought 35% of Juul labs for $12,8B, effectively valuing the company at $38B. Juul is the leader in e-cigarettes sales in the U.S.A. According to management, its revenue was $1 billion for 2018. Altria paid 38x/sales!!!! Way too expensive, but hey, maybe this will help them balance the ever decreasing number of smokers who buy their cigarettes.
Cronos: Altria paid $1,8B for 45% stake while Cronos revenue is $9 million. That’s a 444x price/sales ratio!?!?!?!? Let’s remember that Cronos is a Canadian company, cannabis is still illegal under U.S. Federal law, and it is still investing money to increase its cannabis growth capacity, so I think we wont be able to see any meaningful results from this operation anytime soon.
Because there are a lot of moving parts and these are highly unpredictable, and also because all of these acquisitions are far from significantly altering Altria’s revenue mix in the short term, I’m not really convinced that Altria will be able to grow its revenue in a meaningful way going forward. And if that’s the case, I’m not interested in owning it.
I’m going to take a better look at how the iQOS is contributing to Philip Morris International revenue before I form an opinion. I’ll post that analysis here soon.
4.2. CONCLUSION
This section will be available to paying subscribers in 2019 when we launch the Portfolios.
If you want more, join us at our new Facebook group.
5. DISCLAIMER
The material contained on this web-page is intended for informational purposes only and is neither an offer nor a recommendation to buy or sell any security. We disclaim any liability for loss, damage, cost or other expense which you might incur as a result of any information provided on this website. Always consult with a registered investment advisor or licensed stockbroker before investing. Please read All in Stock full Disclaimer.