Bob Ciura: Tobacco giant Altria Group (NYSE: MO), manufacturer of the Marlboro cigarette brand in the United States, has had an incredible run in recent years. At $62 per share, Altria stock is up 25% in just the past year.
Altria is one of the most beloved stocks out there, and for good reason. It has richly rewarded shareholders for decades on end. Altria has increased its dividend 49 times in the past 46 years. And, according to the company, from 2011-2015 Altria delivered total shareholder return of 204%.
It’s almost impossible to find anything remotely negative written about Altria right now – but that in itself should make investors nervous. Altria’s tremendous rally has come mostly from expansion in its valuation multiple, not from earnings growth. In an environment of falling smoking rates in the U.S., Altria’s rally might just go up in smoke.
Rush for Yield Propels Rally
In the continued low interest rate environment, investors are starved for yield. In the scramble for yield, investors have bid up stocks like Altria to levels that seem unsustainable. Altria stock now trades for 24 times earnings, a level not seen in years. For evidence of this, consider how far Altria’s valuation has expanded over the past several years.
At the end of 2010, Altria’s closing price was $24; it’s since more than doubled. Its price-earnings multiple at year end 2010 was 13; today it’s almost double that. In fact, Altria’s P/E ratio sits very close to a 10-year high.
This is a significant concern, because Altria isn’t growing. Altria generated $24 billion in revenue in 2010. In 2015, Altria’s revenue stood at $25.4 billion. Its revenue grew barely more than 5% in five years.
Investors have bid up the price of Altria stock, likely due to its dividend. With interest rates still near zero and bond yields very low, it’s extremely hard to find safe yield. Stocks like Altria are a haven for investors hungry for yield. For many years, Altria stock yielded 5% or higher, which attracted a lot of interest from income investors.
But Altria’s tremendous rally has pushed down its dividend yield, since price and yield are inversely related. Altria’s dividend yield is now all the way down to 3.5%, which is near a ten-year low.
Smoking Rates on the Decline
Normally, Altria’s stock price rally would be a sign that its fundamentals were improving. But that’s not necessarily the case. To be sure, Altria is generating earnings growth—including 4% earnings growth last year—based largely on cost cuts and stock buybacks.
But those measures can only take the company so far. At some point, Altria will need to grow revenue in order to keep growing its earnings, and consequently, its dividend. But that just doesn’t seem likely, given the declining smoking rates in the United States.
This is weighing on Altria’s core smokeable products business. While Altria does have other products in its portfolio, including a wine business, chewing tobacco products and a 27% stake in brewer SABMiller(OTC: SBMRY), its Marlboro and other cigarette brands still represent roughly 90% of its total profit.
That’s a problem, because smoking rates are consistently on the decline in the United States. According to the Centers for Disease Control, 42% of U.S. adults were cigarette smokers in 1965. In 2013, just 16% of U.S. adults were cigarette smokers.
This is being reflected in Altria’s financial reports. Its total cigarette shipment volumes fell 2.6% in the fourth quarter.