I’ve received a couple of emails in recent months asking about big tobacco stock valuations. I guess a lot of folks have been looking at their stock price charts recently! Anyway, the headline numbers are certainly eye-opining. Altria (NYSE: MO) stock, for example, has lost around 25% from its 2017 peak. Philip Morris International has lost a meaty 33% over roughly the same period. The British giants have also fared pretty badly: British American Tobacco has lost around 30% of its value over the past year, while Imperial Brands has lost about the same from its 2016 peak.
I’m not sure that there’s any real mystery behind these movements. Back at the start of 2010 Altria was trading at a price-to-earnings ratio of around 10x prior year profits. By the end of 2016 that figure had ballooned to around 24x prior year earnings. All of the other big tobacco stocks mentioned above followed a similar pattern. Right now Altria stock trades at 14x estimated 2018 earnings. Is it all that surprising to see a tobacco stock contract from trading at over 20x earnings to 14x earnings? Not really, no.
More importantly, has anything really changed at Altria? Again, you’d probably answer no to that question too. Through Philip Morris USA it still commands around 45% of the domestic tobacco market with its iconic Marlboro brand. Cigarette volumes keep on declining, but Altria keeps on making more money. Back in 2010, for instance, it shipped 122 billion units of Marlboro. Total earnings per share for the year came in at around $1.90. Last year, Marlboro shipment volume clocked in at just under 100 billion units – nearly 20% lower than the start of the decade. Total profit per share (normalized), however, was up to around $3.50 – 85% higher than 2010. The company has a knack of growing earnings even as the core business declines.
That aside, there’s two other things I like about Altria in particular. The first is that its balance sheet is fairly conservative compared to its peers, with net debt currently standing at around $11.75 billion. Even after netting out cash dividends, Altria should pump out over $1.5 billion in surplus cash this year. There is, of course, another side to the debt question: valuation. Right now, Altria shares trade at an earnings yield of 7%. I’d call that figure fairly ‘honest’ because the debt adjusted number is not particularly noteworthy. Compare that to a stock like British American Tobacco. It currently trades at around the same level but has over £45 billion in net debt on its balance sheet. As a consequence its debt adjusted valuation metrics are actually much higher.
The second thing to like about Altria is its stake in global beer giant Anheuser-Busch InBev. It owns around two-hundred million shares, most of which are currently locked in as a result of the SABMiller deal back in 2016. Given the Budweiser and Stella Artois owner makes yearly profits of around $4.50 per share, that means Altria’s stake currently nets it around $900 million per annum. I’m not sure what the long-term plans are here, but they are locked in for at least another four years. Altria also has two members on the Anheuser-Busch InBev board.
Altria Stock Going Forward
The secret to Altria’s mind blowing historical returns comes in two parts. The first was actually summed up pretty well by the CEO, Martin Barrington, when he was fielding questions about earnings growth from analysts last year:
…I think the best evidence of what we would have done absent the tax reform is what we have done, which is we have grown at about an 8% adjusted EPS growth rate through thick and thin.
To compliment that growth, we regularly had a very low valuation base. I mean Altria traded with 10%+ earnings yields for years back in the Philip Morris days and its early years as a separate company. Take 10% minimum as your base yield, tack on long-term earnings growth of 8% per annum and you will get good shareholder returns. Not much of a secret after all!
Now, you all know that growth-wise it’s hard to get excited about tobacco. Between regulatory beatdowns, litigation and declining volumes the future hasn’t looked bright on paper for about twenty-five years. Yet, as mentioned before, Altria keeps on making more money. I think these guys know what makes a great business. Just look at some of the investments Altria has been associated with down the years; the likes of Nabisco, Kraft, Miller Brewing, SABMiller and now Anheuser-Busch InBev. These guys are proven capital allocators running a business that will throw off $8 billion in net profit this year. With a 7% earnings yield it will probably do okay for shareholders because the expectations and debt levels are not insanely high.