Altria: Up in the Smoke

Altria (MO) came on my radar because of the Juul controversy.

The stock had fallen from a high of ~$75/share in mid-2017 to around $40 at the time of writing. The dividend yield had risen above 8% ($3.36/share), and earnings yield was more than 10%. The company is committed to return 80% of earnings back to shareholders.

Revenue has been mostly flat around $25B for the past several years. Over ~85% of the sales and EBIT still comes from smokeable products; the remaining is split between smokeless, wine and other products. Demand is highly predictable, but in secular decline (around 4%/year). Price increases have prevented revenue from declining (as fast).

MO is very profitable (20-25% net margins) with $7B dropping to the bottom line. The FCF is comparable with net income, and CapEx is light. ROIC is high, but not easy to measure. Inputs are commodities, and the output is a highly regulated product with brand value, and a commanding market share.

Management has been a good steward, and MO has been one of the most rewarding stocks for shareholders over the past several decades. Share count is declining (1.876B shares out), for a market cap of $75B at current prices.

Now for the unpleasant facts.

Long term debt is quite high at $27B. It doubled over 2018, fueled by optically expensive stakes in Juul Labs ($12.8B investment for 35% economic stake), and Cronos Group ($1.8B for 45% equity stake). Despite the low interest rate (4.1%), annual interest payments will touch $1B for the next few years. Currently debt/sales ~ 1x, and debt/EBIT ~ 2.8x. So not alarming, especially since cash flows are ample: EBIT/interest is 8-9x. But this is something to keep an eye on. If buybacks are carried out at low prices, using 4.1% debt to retire 8% yielding shares at a discount to intrinsic value is value generative.

What about valuation?

At a gross level, the PE of 10 is very attractive. But MO contains lots of publicly traded parts, which can be valued at market.

It owns a 10.2% stake in BUD. At $94/share ($185B mcap) currently, this represents an economic interest of $18.8B or $10/share. Therefore 25% of the value of MO is supported by its interest in Anheuser-Busch.

The $1.8B invested in Cronos is now work about $1.4B, or <$1/share right now. The value here is optionality, and diversification.

Juul is more interesting. The headlines are bad. Targeting teens is bad. That said, I have friends, who have found Juul helpful in kicking their cigarette habits. I think there is certainly value here. How much is the question?

Juul was’t cheap. 2018 revenues were ~$2B, so MO paid about 20x sales for its interest. For 2019, I saw sales numbers of $3.4B bandied about before the wave of negative headlines hit. Regardless, Juul is growing superfast, and has the potential to be a significant contributor to MO’s bottomline in the future. If regulation develops around vaping, it could actually help MO build a moat. But there is short-term pain no doubt!

In summary, at $40/share, the valuation is undemanding. I would expect a return of 8-10% purely from the business. Any re-rating to the historical 15 P/E would improve returns to the mid-teens.

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