Despite a massive slump in American smoking rates over multiple decades, Altria (NYSE:MO) has continued to pass cash along to its shareholders.
Today, the stock’s yield is in the high single digits, making it an enticing stock for income-oriented investors. Altria stock pays $3.76 per share annually, resulting in a yield of 7.98 percent.
Management has been increasing the payout annually for the past 12 years. Over the coming three years, Altria’s dividend is projected to grow at a modest annualized rate of 3.33 percent.
While Altria is a widely favored dividend stock, it should be noted that the company is largely mature. As a result, its rate of dividend growth is slow and steady. Over the last 10 years, management has increased Altria’s dividend at a compounded rate of 8.1 percent annually. In the last three, however, that rate is just under 4 percent.
Will Altria Be Able to Maintain Its Dividend?
One of the key questions for investors about Altria is whether the company can maintain its dividend over the long term. As a manufacturer of cigarettes and tobacco products, Altria is facing headwinds both from continued government efforts to suppress its business and an organic slowdown in the American smoking rate.
These challenges, however, have not been sufficient to stop Altria’s free cash flow growth. Between 2011 and 2021, the company’s annual FCF rose from $3.476 billion to $8.236 billion.
This massive increase in FCF occurred even as the smoking rate among American consumers dropped during the same period, demonstrating Altria’s significant pricing power among its core customer base. FCF also increased during the COVID-19 pandemic, showing the resilience of Altria as a provider of a day-to-day staple for its customers during difficult economic times.
One red flag for Altria’s dividend, however, is its payout ratio. At over 140 percent of GAAP earnings, this ratio is far outside of a safe range. Management’s self-stated target payout ratio is 80 percent, a fact that calls into question how long the company can operate at its current payout ratio.
Ultimately, though, Altria appears unlikely to cut its dividend in the immediate future. The adjusted dividend coverage ratio for the stock is 1.31, meaning that the company isn’t facing an inability to cover its dividend. While dividend growth will very likely be slow for the next few years, a dividend cut is a last-ditch effort that management probably won’t be forced to take.
Altria Growth and Future Prospects
Over the next five years, analysts expect Altria to grow at an annualized rate of just over 4 percent. While this would be far too low for a sensible growth investment, this stock’s primary appeal is its ability to reward shareholders with dividends. This fact is also reflected in Altria’s expected share price target, which is nearly flat over the coming 12 months.
Altria is currently working to diversify its business, potentially shielding it from future declines in cigarette sales revenue. One of its most significant efforts in this area is its 10 percent stake in brewery stock Anheuser-Busch Inbev.
Altria also owns 45 percent of Cronos Group, a company engaged in research and development of consumer cannabis products. It should be noted that Altria significantly overpaid for its Cronos investment, but the move into the cannabis market could be profitable on a long-term basis.
Between maintaining its market position, producing marginal positive growth and using some of its cash to invest in diversification, Altria appears to be in a decent position to continue generating the cash flows needed to maintain its dividends. Investors shouldn’t go into Altria expecting it to be a high-growth stock, but there’s little reason to believe the company will contract in the next few years.
Market Size Is Reducing
Although Altria has been a historically stable income producer, the company’s business model presents certain inherent risks. A continued drop in smoking rates in the United States could eventually threaten Altria’s cash flows. Only about 15 percent of Americans report smoking cigarettes, a number that has dropped steadily over the past several decades.
Although Altria and other tobacco manufacturers have been able to raise prices enough to offset falling demand, this strategy could eventually hit a point of diminishing returns. Cigarette smokers can only pay so much per pack before being forced to cut back. While Altria’s pricing power is substantial, it will eventually reach its limits.
Altria’s management has also made some questionable business decisions in recent years. Chief among these was the acquisition of a major stake in vape brand Juul. The company’s $13 billion investment rapidly lost most of its value when US regulators targeted Juul amid a crackdown on vaping products. Altria also spun off its popular Philip Morris International division, which was one of its better growth drivers.
Finally, Altria will likely continue to face headwinds from government regulators. Earlier this year, for example, the FDA proposed a ban on flavored tobacco products that included widely popular menthol cigarettes.
The announcement of this action drove Altria stock down nearly 20 percent, showing how sensitive the stock can be to new regulatory standards. The Biden administration has also proposed a cap on nicotine content in cigarettes that would impose heavy compliance costs on manufacturers if enacted.
Is Altria a Buy?
Despite being a bit of a mixed bag, Altria could be a good buy for investors focused on producing steady income from their portfolios. The one serious challenge from an investor perspective in the short-term is the extremely high dividend payout ratio.
Although this is concerning, Altria’s ability to generate free cash flow should allow it to keep its dividend up. Management may have to institute cost-cutting measures to improve earnings, but there doesn’t seem to be an immediate risk of a dividend cut.
Altria could also be slightly undervalued when its dividend is taken into account. The stock trades at 9.7 times forward earnings. Given that its dividend yield is nearly 8 percent, this places very little demand for growth on Altria to justify its price. Altria’s lack of significant debt further bolsters this value argument.
While growth investors may not find Altria particularly attractive, dividend investors could have a hard time passing up an established company with such a high yield. Even though long-term trends don’t favor Altria’s cigarette business, there still appears to be plenty of cash potential left in this stock.