Altria: A Strong Play in Tobacco
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Altria (NYSE: MO) is a holding company, whose dominant operating unit is Philip Morris USA. Altria also owns a minority position in SABMiller, the former U.S. Tobacco, a cigar unit (think Black and Mild), a winery, and a finance unit. The domestic cigarette unit dwarfs the other units.
Therein lays both the allure, and the problem with Altria. In being limited to the domestic cigarette market, it is married to a market in long term decline. The only ways to combat the overall decline in cigarette consumption is to up prices, which only exacerbates the problem. Altria management is used to this issue, as cigarette smoking has been in decline for a generation. The company continues to churn out money, and reward shareholders, that will not be ending any time soon.
In its first quarter of 2012, Altria produced revenues of $5.65 billion, a fraction of one percent above the year ago quarter. Earnings were $973 million, or $0.48 per share. This compares with earnings in the first quarter of 2011 of $937 million, or $0.45 per share. Both revenue and earnings were in line with analysts' expectations.
The fact that revenues were able to stay stable were another testament to management's adroit flexibility. Cigarette volume for the quarter was down 2.6%, despite an 18% jump in discount brands in the first quarter of 2012 versus the first quarter of 2011. But due to price increases, revenues were down just under one percent in the segment. Cigar volume was up 14%, but that again is such a small fraction of the company that overall volume still fell for “smoke” products 2.5%. Smokeless tobacco product sales were off, on a volume basis, by 7.5%. Wine shipments were up 6.6%. Management likes to boast of market share, and while that is important, market share in the tobacco business is akin to being the captain of a sinking ship. Tobacco is not in a cyclical decline. It is in a long term, slow but sure death spiral.
For the time being, by reducing costs as Altria has done, profits can be maintained. But if I were running Altria, I would retire as much debt as possible, and then find an appropriate and large acquisition target that would help to reverse the revenue losses of Altria's core products. Back in the 1980's, that was the justification for acquiring companies such as General Foods and Kraft. It makes no less sense to diversify away from tobacco now than it did twenty five years ago.
For now, Altria has a stated goal to return the majority of its earnings to shareholders each year. And by majority, Altria means as much as 80% of earnings. The company's total return to shareholders has exceeded the Standard and Poor’s 500 index's average return each of the last twelve years in a row. It pays a dividend yield of over 5.0%, and has raised its dividend 42 years in a row. It launched two separate $1 billion share buybacks last year, and still has over $500 million authority on the later of the two plans to make share purchases. At the company's book value of less than $2.00 per share, frankly, these share purchases make little sense.
I am not going to discuss litigation issues today. That does not mean they do not exist. What it means is that litigation will always be a part of Altria's business, and there will be excise tax increases, and there will be an occasional judgment. None of these will surprise anyone, and it is simply a fact of life.
While Altria finds ways to increase market share and preserve its right to sell a product universally known to cause health impairments, Schweitzer-Mauduit International (NYSE: SWM) is in court working to protect its patents to keep cigarettes more safe. Schweitzer holds an 80% domestic market share of fire resistant cigarette papers. As these specialty papers have become mandatory in every state in the country, Schweitzer's revenues and profits have grown at an astonishing clip. Earnings came in at just four cents a share in 2008, rose to $2.20 per share in 2010, and came to $5.36 per share last year. It does not release first quarter earnings until May 2, and analysts are looking for $1.78 per share. I suspect Schweitzer will meet or beat that estimate.
Schweitzer had its initial complaint against a German paper maker for patent infringement denied by an administrative law judge in February, 2012. But on April 3rd, the U.S. Trade Commission announced a review of the judge's findings by a six person panel. I will keep my eyes out for a ruling in the matter; and you should too.
Schweitzer is trading at a five year PEG of 0.62, suggesting it is undervalued at this time. Analysts have a 12 month target of $83.33, about a 25% premium to today's stock price. That is just a small portion of this company's potential, and I urge you to look more closely into this growth company.
One reason Altria is in the shape it is in is that it spun off the growing part of its business, Philip Morris International (NYSE: PM) in 2008. The idea was the international division would have less issue with regulation and lawsuit, and could pursue growth in emerging markets without being encumbered by long term demand declines in the United States.
Philip Morris had a terrific first quarter, with revenues up 9.0%, despite negative currency fluctuations, to $18.02 billion. Growth was especially strong in Asia (up 19.5%) and the Eastern Europe/Africa/ Middle East group (up 8.8%). Actual unit volume was up 5.5%, led by its Marlboro brand growth. Profit of $2.16 billion was up 12.6% from the year earlier quarter. Per share earnings of $1.25 beat last year's amount by 17.9% due to aggressive share buybacks.
Philip Morris does not have a free pass outside the United States. Australia for instance aims to reduce smoking by mandating plain packaging. But with sales in about 180 countries outside the U.S., Philip Morris has plenty of plump fish to fry, so to speak. For those wanting a pure tobacco play, it is the best of breed.
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