Could Shorts Get Smoked?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In a recent article, “Do the Shorts Know Something You Don't” by The Motley Fool's Rich Duprey, I was actually shocked by one of the names I saw. In this series of articles, companies with a significant increase in short interest are examined. In this particular article, the first name was Altria (NYSE: MO). This is somewhat amazing to me because Altria is one of the most well known companies in the country. This is the old Philip Morris company, and between their spin-off of Kraft and Philip Morris International (NYSE: PM), is arguably the best returning stock of the last few decades. Why in the world would shorts think going after this company is a good idea?
Rich's own take is, “Altria isn't the company it once was...” That is certainly true since as I just mentioned, Philip Morris International is no longer part of the equation, and anti-smoking activists have become more vocal in the last several years. He does note that Marlboro is the dominant brand in the cigarette industry with 42.3% market share, and that Copenhagen and Skoal own more than half the smokeless tobacco market. In the cigarette market, Altria is fighting a losing battle. Cigarette volumes have been declining and the company is making up for this by raising prices and cutting costs. The problem is this can't continue forever. This is probably the focus of anyone shorting the stock. However, this is not all there is to the Altria story.
The company actually operates in five segments: cigarettes, smokeless products, cigars, wine, and financial services. While cigarettes provide the lions share of both revenue and profits, there is diversity to the company's income. The huge amount of cash flow generated primarily from the cigarettes business gives Altria a lot of options going forward. Just as an example, for full year 2011, Altria generated $3.6 billion in operating cash flow versus only $105 million in capital expenditures.
However, the company's huge dividend payments equaled $3.222 billion. With roughly $3.5 billion in free cash flow and $3.222 billion in dividends, this still leaves about $895 million in cash flow after dividends. This number is what shorts might be watching. If in a full year there is $895 million in left over cash flow, with 2.03 billion shares outstanding there isn't a lot of room left for continued dividend increases.
The problem with this theory is that in the next few years analysts expect Altria to grow earnings by 6%. Since the company's operating cash flow has been growing slightly faster than net income, this 6% net income growth should generate 6-7% operating cash flow growth. While this isn't huge growth, it's certainly enough for the company to issue small dividend increases in the future. Even if Altria were to break its string of dividend increases, the current yield of 4.72% should support the stock. I just don't see this as a great stock to short. The company has huge cash flow and with over $3 billion in cash on the balance sheet, so the company is not in any danger. I guess my issue with Altria isn't as much that I think the stock should be shorted, as I think there are more attractive plays.
Let's consider a few other companies in the same industry and see if any of these competitors seem like better deals. We'll use Philip Morris International (NYSE: PM), Lorillard (NYSE: LO), and Reynolds American (NYSE: RAI) to get an idea of how Altria compares on a few metrics. Both Lorillard and Reynolds compete in the discount cigarettes market, which is becoming more popular as cigarette prices get more expensive. Philip Morris International markets the brands that Altria owns in the U.S., but they compete in the less heavily regulated international markets.
|
Name |
P/E On '12 Earnings |
Growth Expected |
Yield |
Op. Cash Flow Growth Last 3 Yrs |
Long-Term Debt To Assets |
|
Altria |
15.79 |
6.03% |
4.72% |
4.94% |
35.41% |
|
Philip Morris Int. |
17.02 |
10.09% |
3.49% |
33.55% |
41.78% |
|
Lorillard |
15.41 |
9.70% |
4.64% |
14.08% |
86.27% |
|
Reynolds American |
15.3 |
6.97% |
5.23% |
2.39% |
19.72% |
There are two companies that jump out at me. The first is Philip Morris International. If you are looking for arguably the best play in the industry, look no further. Philip Morris has a much stronger growth rate than Altria, you don't give up much in dividend, and the company is growing operating cash flow at a significantly faster rate. If you are looking for a better play than Altria with very similar characteristics, I would consider Reynolds American. Reynolds sells for a slightly cheaper forward valuation, while expectations for growth are slightly faster. In addition, Reynolds has the better dividend yield, and the company carries less relative debt. Neither company's operating cash flow growth is particularly impressive, but with Reynolds beating Altria in four of five categories, it just looks like a better deal.
So long story short, I don't agree with short sellers on Altria, but I also wouldn't be going out of my way to buy Altria either. There are better deals in the same industry whether you are looking for a better dividend yield (Reynolds) or better growth (Philip Morris Intl.).
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
