Altria (NYSE: MO) released its second quarter results last week with mixed results. On the positive side, it reaffirmed its full-year EPS forecast of $4.79 to $4.93, representing healthy growth of 4% to 7% from its 2021 level. , the company continues to report the chronic decline of its smoking products segment. Sales of smoking products fell 0.7% year-on-year. The company continued to demonstrate its pricing power, and the decline was mainly due to the volume of shipments.
For me, the update of fundamental long-term relevance is the following announcement involving JUUL. The company began delisting its JUUL shortly after the $13 billion acquisition, and I believe management eventually decided to exit the JUUL business. As you can see from CEO Billy Gifford’s following comments (abbreviated and underlined by me), management is considering exit options.
With respect to our investment in JUUL… as of June 30, our valuation is estimated at $450 million, reflecting a range of regulatory, liquidity and market outcomes. Under the terms of our relationship agreement with JUUL, we have the option of being released from our non-competition obligation subject to several conditions, including the fair value of our investments, if the fair value of our investment does not exceed 10% of the initial book value of $12.8 billion.
I feel sorry for MO, an otherwise shrewd company, for making this bad decision. He adds another case study to illustrate that it’s never a good idea to chase the hype. I also feel sorry for the investors who bought MO stock right after the JUUL acquisition. It’s a speculative investment that unfortunately didn’t work out.
However, at this point, with JUUL’s valuation almost completely removed from MO’s share price, I think it’s actually a good time to consider an MO position for several reasons to be expanded on below.
Dividends and dividend security
First, let’s address the elephant in the room: dividends. The dividends are high enough to arouse suspicion. The dividend yield for MO fluctuated in a range between around 3.3% and up to 10% with an average of 6.45%, as you can see in the following graph. Currently, the yield stands at 8.14%, more than 26% above the historical average.
But my view is that the acquisition of JUUL never helped dividends and its removal has no relevance to the dividend either. And you can clearly see that in the bottom panel of the chart, which shows MO’s payout ratio in terms of cash flow. MO has done a consistent job of managing its dividend payout in the past. Payout ratios fluctuated around an average of approximately 80% before and after the acquisition of JUUL.
Looking ahead, my projection for its cash payout ratios is between 76% and 78%, well below its historical average. As mentioned above, it reaffirmed its full-year EPS forecast of $4.79 to $4.93. And historically, it has maintained a remarkably high profit-to-cash conversion rate (averaging 96-97%). I project $3.65 dividend payout per share for 2022-2023. If you put all the other numbers above together, you would see its cash payout ratio to be between 76% and 78%, not only in line with the historical range, but also below its historical average. I don’t see any signs of concern here.
Capital allocation and share buyback
In fact, MO not only generates enough cash to comfortably cover its dividends, but it will also have plenty of capital allocation flexibility to boost shareholder returns in other ways. Let’s take stock buyback as an example, he systematically bought back his own shares, as you can see from the following table. Cumulatively, its net shares outstanding have fallen from 2.01 billion 10 years ago to approximately 1.81 billion currently (an annual reduction rate of approximately 1%).
Going forward, the company will continue with buyouts, as CFO Sal Mancuso (abbreviated and underlined by me) commented during the second quarter RE. For me, such buyback programs are a no-brainer and will be highly creditworthy to shareholders for several reasons. MO’s return on capital is so much higher than its cost of capital. As detailed in my previous articles, its ROCE (return on capital employed) is greater than 100% while its cost of capital should not exceed 10%. Second, its current valuation is quite compressed (at a single-digit PE FW of around 9x). And to top it off, the company will be able to maintain a strong balance sheet and stable leverage ratio at the same time.
We have approximately $750 million remaining under the currently authorized $3.5 billion share buyback program, which we expect to complete by the end of this year. Our balance sheet remains solid. And from the end of the second quarter, our the debt to EBITDA ratio was 2.3x. In August, we plan to repay $1.1 billion of maturing notes with available cash.
Based on the above analysis of company fundamentals, I will consider a conservative scenario here, as shown in the waterfall chart below. This scenario considers the following feedback drivers:
- 2.5% growth in total profit, essentially only adjusted for inflation.
- 1% share buybacks, in line with its historical trend.
- Dividend of 8% on average (assuming that the increase in the dividend would maintain the dividend yield at approximately the current level).
- No valuation expansion at all.
Based on the conservative estimate above, the annual return should be in the double digit range (say 11.5%).
Final thoughts and risks
To sum up, the thesis here is that removing JUUL from its stock price actually reduced investment risk. The acquisition of JUUL never helped its dividends (or earnings) and its removal has no relevance to its dividends or earnings either. At the same time, the removal of JUUL’s valuation has significantly reduced valuation risks.
Looking ahead, I still see a cash cow business with superb ROCE and capital allocation flexibility. And even a conservative estimate indicates annual return potential in the double-digit range of around 11.5%. Additionally, most of the return (about 8%) will come from its current dividends, adding another layer of investment security.
Finally, the risks. The secular decline of its smokable products is a major risk here. Depending on how you model the decline rates of shipping volume, its pricing power, and inflation, you can arrive at a wide range of future earnings. These uncertainties are summarized in the large consensus forecast variance, as shown below. The gap between the optimistic and pessimistic forecasts is greater than a factor of 1.3x even at 3 years ($6.03 EPS vs. $4.54 EPS in 2025).
#Altria #Stock #JUULess #Future #Reduced #Investment #Risks #NYSEMO
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