Although I remain cautious about the broader market’s modest overvaluation right now, I still find it hard to refrain from putting new capital to work in selective opportunities. What can I say? I belong in Dividend Addicts Anonymous! There aren’t a lot of compelling opportunities out there to be sure, but at the same time any cash sitting in my brokerage account isn’t earning dividends which can then be reinvested back into high quality companies to earn even more dividends which get raised organically, funding even more purchases in the future. So, while I’m not overly excited about investing fresh capital right now, I’ve also never been a big fan of holding a lot of cash (a horrible asset guaranteed to lose money over time to the ravages of inflation).
As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.
This purchase is an addition to an existing position, as I initiated a position in Altria Group, Inc. back in September, 2010 for $23.88 per share.
Overall, I’m confident that MO will deliver solid returns over the medium-term, as they continue to dominate the U.S. tobacco industry with #1 brand Marlboro. Altria has a significant market share of a mature U.S. cigarette market, accounting for nearly half of all domestic cigarette shipments. Although this market is in secular decline as shipments slowly decline, this is still a very lucrative business and Altria Group, Inc. throws off a lot of free cash flow, of which they use primarily to fund a very generous dividend.
Altria Group, Inc. operates as a holding company with a number of subsidiaries, including Philip Morris USA Inc., U.S. Smokeless Tobacco Company LLC, John Middleton Co., Ste. Michelle Wine Estates Ltd. and Philip Morris Capital Corporation. They also hold approximately 26.9% of the economic and voting rights of SABMiller plc (SAB).
Although MO is mostly known for the Marlboro brand (and rightly so), they are actually nicely diversified into smokeless tobacco products with Copenhagen and Skoal representing their premium brands here. Black & Mild is their premium brand offering in the machine-made cigars and their wine business has a premium brand in Chateau Ste. Michelle, with wine being their strongest segment for revenue growth YOY. One potential game changer is the offering of their new e-cigarette Mark Ten, which will be manufactured under the Nu Mark subsidiary. Altria is, unfortunately, the last of the major U.S. cigarette manufacturers to enter the e-cig market, but they are aiming to be the best as they believe Mark Ten will mimic a traditional cigarette’s flavor and draw. They’re currently rolling this product out in Indiana. Although e-cigs command just 1% of the market share of U.S. cigarettes, this segment is expected to grow significantly over the coming years, so it’s important that Altria get on board this train right away.
Although I’m not optimistic about the declining U.S. traditional cigarette volumes reversing this trend, I’m confident that management can continue to overcome these headwinds by strength in the other segments, the offset of volume declines via price increases and expense reductions and the introduction of new products like Mark Ten. MO has continued to operate in an extremely challenging environment, and yet net revenue was up 3.4% in 2012 over 2011 and EPS was up 25.6%. They raised the dividend 7.6% last year, and I expect the dividend to be raised by at least 6% within the next couple weeks, perhaps more. The balance sheet remains heavily leveraged, but not uncommonly so among tobacco companies as they tend to pass off most of the cash they generate back to shareholders.
But let’s talk about dividends, shall we? They have a 44-year track record of raising the dividend. That’s one of the longest records around, which is doubly amazing considering the litigation, taxation and regulation this company has had to overcome over the last 20 years. They have a 10-year dividend growth rate of 11.4% and they show no signs of abating their dividend raises. The current entry yield based on my purchase price is 5.1%. Although not Altria’s highest yield offering on a historical basis, it’s still quite an attractive yield based on today’s low interest rate environment.
I valued shares for MO using a Dividend Discount Model. I used more conservative numbers than I usually do to account for uncertainty regarding operations and reduction in traditional cigarette volumes. I used a 10% discount rate and a 5% dividend growth rate (well below historical norms) and I came up with a Fair Value of $37 per share. I think an argument could be made that MO shares are trading pretty close to intrinsic value right now, which isn’t too bad considering the strong yield and lack of compelling value in the broader market, especially among consumer goods companies. The P/E ratio currently stands at 15.75, which while again is not Altria’s lowest P/E ratio over the last 5 years, is very attractive when most companies in this sector are selling for P/E ratios closer to 20 or above.
This purchase adds $49.28 to my annual dividend income based on the current $0.44 quarterly per share dividend. Although, as I pointed out above I do expect this to be raised in the next couple weeks.
I’m currently invested in 37 companies, as this was an addition to a company I already have an ownership stake in.
Some current analyst opinions on my recent purchase:
*Morningstar rates MO as a 2/5 star valuation with a Fair Value estimate of $31.00.
*S&P rates MO as a 4/5 star Buy with a Fair Value calculation of $35.40.
I’ll update my Freedom Fund in early September to reflect my recent addition.
Full Disclosure: Long MO
How about you? A fan of MO money? Good investment? Bad investment?
Thanks for reading.
Edit: Added P/E ratio.
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