Our first idea today is a tobacco company that has an 8.55% dividend yield, paid monthly. Our next recommendation is profit-taking on a previous pick.
Buy: Altria Group, Inc. (MO)
From Cabot Dividend Investor
Altria Group is the largest U.S. domestic cigarette maker and one of the largest in the world. The company is the domestic part of the old Philip Morris that spun off the international division in the form of Philip Morris International (PM) in 2008. Altria now operates primarily in the United States.
In addition to cigarettes, Altria also sells E-cigarettes, marijuana, beer, wine, and smokeless products. Altria also owns a 10.2% stake in the world’s largest brewer Anheuser-Busch InBev (BUD). It may seem like a diversified company, but it really isn’t. About 85% of net revenues are generated from cigarettes and the overwhelming majority of that is from its flagship Marlboro brand, which commands a stratospheric 40%-plus cigarette market share in the U.S.
That’s a problem. In case you haven’t heard, cigarettes are bad for you. The volume of cigarette smoking is declining by about 4% to 6% per year. Of course, it has been declining at a 4% pace for decades. And over that time Altria has been able to more than compensate for the declines by raising prices and via share buybacks. The company still grew annual earnings at a solid rate and had been one of the best performing large stocks in the index.
But things are changing.
The rate of annual volume declines is increasing because more people are opting for E-cigarettes, especially young smokers. To answer that problem, Altria purchased a 35% stake in dominant E-cigarette brand JUUL in late 2018 for $12.8 billion. It has since been the acquisition from Hell. JUUL has been under relentless assault by regulators primarily for marketing to young people. There is now even a question if E-cigarettes will be allowed to be sold at all.
Altria has already written down $8.6 billion of the investment. The market hasn’t liked this, and the stock is down about 50% from the 2017 high and near a five-year low.
But here’s the thing. If E-cigarettes get sued out of business Altria will sell more cigarettes. If E-cigarettes survive, Altria owns the dominant company in the space. It’s will ring the register either way. Plus, Altria has other growth opportunities.
In late 2018, Altria purchased a 45% stake in Canadian Cannabis company Cronos (CRON) for $1.8 billion. Legal cannabis is a huge growth industry still in its infancy. But the growth is undeniable. The trend toward legalization is clear and could accelerate as states opt for additional tax revenue to compensate for the budget shortfalls from this recession.
Altria, with its unparalleled regulatory expertise, deep pockets and marketing should be able to cash in on some of that growth going forward. As well, the company has a joint venture with Philip Morris International to sell heated tobacco product IQOS throughout the U.S. It is the only such product with FDA approval and could potentially capture much of what has been lost by E-cigarettes.
In the meantime, the company continues to grow earnings per share. Management is forecasting high single digit annual growth for the next several years. Earnings grew over 18% in the first quarter as people are smoking more during the pandemic.
Is that massive dividend yield safe? I think it is rock solid. The company has a rather high 80% payout ratio, but that is the historical average. And the company has raised the payout every year for the last 50 years.
Historically, this has been one of the best and most reliable dividend paying companies on the market because the company generates an obscene amount of free cash flow, money left over after expenses. To give you an idea, in 2019 Altria generated $7.6 billion in free cash flow and paid $6.1 billion in dividends.
This is one of those companies that is actually doing better during this recession as people tend to smoke more. It can offset volume declines with price hikes and share buybacks. But it also has some promising growth prospects for the longer term. Meanwhile, that big fat dividend should be safe, and the stock is priced near a five-year low.
Tom Hutchinson, Cabot Dividend Investor,cabotwealth.com, 978-745-5532, June 10, 2020