One Big Dividend Stock to Own

Shweta is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As an investor I always want to focus on the consistently-paying dividend stocks that act as a hedge against inflation while increasing my cash returns. I was exploring some profitable companies with a very high dividend yield for my portfolio, and while researching this I came across the leading manufacturer of cigarettes and smokeless products in the US: Altria Group (NYSE: MO). This company has always been a consistent performer in the tobacco industry and has returned good value to its shareholders. Apart from the few years around 2008 when the dividends were affected due to the spin-off of its international operations as Philip Morris, the company has shown stable and consistent growth in its dividends. Altria's current dividend yield is 5.30%. Let’s have a look at its dividend growth figures over the last nine years.

Year

Dividend Growth

2002

9.91%

2003

8.20%

2004

6.82%

2005

8.51%

2006

8.50%

2007

-8.13%

2008

-44.92%

2009

-21.43%

2010

10.61%

2011

8.22%

Source: ycharts.com

What really catches my attention is the fact that during the last few years, the cigarette smoking rate has actually gone down. With rising health concerns and smoking bans, tobacco companies are facing a decline in their cigarette sales. But, despite all this, Altria is planning its strategies in such a way that it has been able to satisfy its shareholders. Altria has shifted its focus to cost cutting measures to improve its profitability at a time when sales are declining. The company announced a new cost reduction program in October 2011 that aims at reducing the cigarettes related overhead costs. This plan is expected to generate annualized savings of ~$400 million in 2013. This would definitely help the company expand its profitability.

Altria has a dominant 50% market share in the US tobacco industry. However, it faces stiff competition from two strong contenders. With the evolving E-Cigarette market all the players in this industry are focusing their strategies accordingly to capture a larger share in this emerging segment. Let’s analyze Altria’s competitors’ positions.

Lorillard (NYSE: LO) is among the top tobacco manufacturers in the US. The company's leading brand, Newport, with ~12% market share in the US, gives it a unique position among the competitors. With the growing acceptance of E-Cigarettes, most of the tobacco companies are betting on the smokeless segment for their future growth. All the top three players of the industry (Altria, Lorillard and Reynolds American (NYSE: RAI)) are pushing on more and more smokeless tobacco products as cigarette volumes fall. Even Lorillard acquired an electronic cigarette company called Blu e-cigs for ~$135 million in 2Q 2012 to expand its portfolio in the smokeless category. The company also launched a national advertising campaign of Blu e-cigs to increase the awareness about smokeless cigarettes. As a result, e-cigs contributed ~$14 million to the total sales of the company in 3Q12. I see Lorillard's acquisition as a perfect move to mark its presence in this segment. Electronic cigarette sales are expected to increase up to ~$1 billion in the next three years from the current level of just ~$$300 million. And with its diversified portfolio, Lorillard is all set to capitalize on this opportunity.

Along similar lines, Reynolds American is also trying to catch up with the competition in the smokeless segment. The company has already ventured into the electronic cigarettes segment and has its own line of products under the Vuse brand. The company has seen its revenue decline by ~4% this year due to rising prices and falling cigarette sales. Therefore, the alternative segment is a huge opportunity for the company to sustain its second position in the US tobacco industry. Reynolds has recently filed a petition with the FDA for changing the warning labels on its smokeless products. The company wants to present its smokeless products as a less harmful alternative to cigarettes. This is a bold move by the company to promote its products as a safe tobacco product in the US. The decision is still pending, but will surely be a favorable turn of events for the company if approved.

Talking about the E-Cigarette market, I feel Altria should further strengthen its presence in this area. I believe the risks associated with the declining market for cigarettes such as rising excise duties, stricter government regulations are of long-term in nature. Altria has already gained the top spot in smokeless tobacco products under its Copenhagen and Skoal brands. However, I think its potential entry into the E-Cigarette market will open up many new opportunities for the company. The company is looking at the acquisition of E-Cigarette maker NJOY, which holds ~40% of the market share in the US. If the company successfully seals this acquisition, it will automatically gain an upper hand in this highly lucrative and rapidly growing market. The company can also develop some in-house E-Cigarette products by leveraging its partnership with Okono A/S. The company entered into this partnership with the pharma company in the first half of this year to develop innovative smokeless products to enhance its presence in this segment.

To sum up, I think all the three players are favorably positioned to gain from the growing E-Cigarette market. The companies have transformed their strategies to deal with the increasing pressures in the business. However, Altria remains my top pick in this industry. The company has such a strong hold in the US market that even if it increases its product prices it will be able to post a stable growth in revenue. Also, the attractive dividend yield acts as icing on the cake. 


ShwetaDubey has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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