Altria (MO) stock has had a tough time of things in recent years. The Marlboro owner has lost roughly 45% of its value since hitting $77 per share back in mid-2017. A small pile of dividend cash – $10.75 per share to be a bit more precise – cushions the blow a bit, but even so, the stock has been a dog over the past few years. The S&P 500 has put on over 50% in that time, just to provide a benchmark here. Anyway, and as you would expect when things don’t go to plan, this poor performance has attracted plenty of outside criticism.
To expand on that last statement a little, let us consider two of the more prominent talking points. Firstly, the decline of its core cigarette business, which still accounts for most of profit here. Anyway, cigarette shipment volume declined from 140b sticks in 2010 to 100b sticks in 2019. Call that a circa 30% drop in the space of a decade. Volume of the iconic Marlboro brand declined from 122b sticks to 88.5b sticks over the same timeframe. Suffice to say, an entirely US-focused tobacco play does not look like the recipe for growth. In fact, it does not look like the recipe for stable operations at all.
That leads us to the second point: Juul Labs. That particular foray into e-cigarettes cost Altria nearly $13b back in late FY18. That is the amount that it paid in order to acquire a 35% stake in California-based Juul. Back of the envelope math put the deal valuation at around 17x annual sales, which certainly raised eyebrows at the time. Altria has since written down the value of its investment to one-third of that initial consideration, with the Juul fiasco a neat reminder that having a great core business and being a great allocator of capital are two very different things.
Something else that crops up occasionally is the dividend payout ratio. The fact that Altria pays out 80% of earnings by way of dividends is, for some folks, a bad sign. In fairness to the firm, I am not sure that is the case at all. It is seductive to see low payout ratios as good and high payout ratios as bad. I mean, retained profit can fund growth, right? And so it makes sense that not having much is automatically bad. Indeed, I have probably propagated that view right here on the site.
The situation is actually more complicated in reality. Put simply, not all payout ratios are created equally. A firm that generates 10% underlying returns and pays out 50% of its profit will achieve 5% growth assuming it can reinvest its retained profit at that 10% rate. Because Altria’s core business is much more profitable than that, it does not need as much retained profit to fund similar levels of growth. This is why folks assert that high quality businesses should typically trade at premium valuations. They can payout more of their profits directly to shareholders without sacrificing growth. In Altria’s case, it really does not need much retained profit at all.
Just to provide some numbers, let’s see what Altria got up to over its last ten full fiscal years. If my math is right, the firm earned $55.8b in adjusted net income during that time. It paid out roughly $42b in dividend cash, with the extra amount spent on stock buybacks clocking in at $11b. As you can see, everything roughly nets out. The firm’s underlying net income still increased from $3.9b to $7.8b over that period.
Most folks know why so-called ‘big tobacco’ firms like Altria have great businesses, so I shall not go into that. But the fact that Altria’s business is currently great clearly does not give the firm a pass far into the future. Things can, and do, change – and that is clearly the crux of the debate when it comes to tobacco stocks. Raising prices above inflation to more than offset declines in volume has its limits, while fresh regulations and laws could also massively speed that process along. That is before thinking about the impact of litigation, and so on. Again, I think most folks appreciate the risks of investing in tobacco stocks.
With that said, it is more than possible that Altria carries on as it has done for many years to come. I mean, the average 20-pack of Marlboro retails for around $7.50 in the US. Compare that to, say, the UK, where the comparable figure is more like $14 per 20-pack. It looks like the firm still has room to run. Moreover, this is a more attractive proposition at a $42 stock price versus a $77 one. The former is backed by a per-share dividend of $3.38, the latter by $2.54 back in 2017. It is a much lower bar to clear in terms of generating good shareholder returns. In any case, the main point to take away is that, while there are reasons to be cautious here, a high dividend payout ratio is not really one of them.
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