Altria Inc. The Fund @ Sprott Equity Research Sell, Current: $52.50, Price Target: $44.64 March 11, 2015 Spyridoula Maria Karasavva BIBCandidate 2017 Global Financial Management and Systems Equity Analyst [email protected]http://fund.ssb.carleton.ca Kyle Stolys BCom Candidate 2016 Finance Sector Manager [email protected]Updated Investment Thesis 5-Year Performance Source: Bloomberg Decline in cigarette volume The cigarette industry has been experiencing a long term 3-4% annual decline. Despite a rising market share in Marlboro, Altria’s cigarette shipment volume has been following industry’s lead and has been declining around 3% yoy. Well-run low maintenance business with very skilled Management Strengthening Taxes and Litigation pressure Dividend yield Altria’s CAPEX on average equals around 3-4% of the company’s Cash from Operations. Altria also manages to operate efficiently using negative working capital while increases its profitability. New government proposals for excise tax increases focusing on cigarettes but also including machine made large cigars, pipe tobacco and chewable tobacco-derived nicotine products as well as the so far unregulated e-cigarettes. Altria has a long history of paying substantial dividends and increasing them at a high rate. Current yield is 3.70%, which is actually quite low compared the historical yield for the stock. However, high levels of debt and stagnant forecasted EPS growth creates concerns as to whether the impressive growth rate in dividends can be sustained. Stronger U.S. consumer Increases in employment gains result in higher consumer spending and a potential shift from discount to more premium products. Page 1
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Altria Inc.
The Fund @ Sprott Equity Research
Sell, Current: $52.50, Price Target: $44.64 March 11, 2015
Spyridoula Maria Karasavva BIBCandidate 2017 Global Financial Management and Systems Equity Analyst [email protected] http://fund.ssb.carleton.ca
The cigarette industry has been experiencing a long term 3-4% annual decline. Despite a rising market share in Marlboro, Altria’s cigarette shipment volume has been following industry’s lead and has been declining around 3% yoy.
Well-run low maintenance business with very skilled Management
Strengthening Taxes and Litigation pressure
Dividend yield
Altria’s CAPEX on average equals around 3-4% of the company’s Cash from Operations.
Altria also manages to operate efficiently using negative working capital while increases its
profitability.
New government proposals for excise tax increases focusing on cigarettes but also including machine made large cigars, pipe tobacco and chewable tobacco-derived nicotine
products as well as the so far unregulated e-cigarettes.
Altria has a long history of paying substantial dividends and increasing them at a high rate.
Current yield is 3.70%, which is actually quite low compared the historical yield for the
stock. However, high levels of debt and stagnant forecasted EPS growth creates concerns
as to whether the impressive growth rate in dividends can be sustained.
Stronger U.S. consumer
Increases in employment gains result in higher consumer spending and a potential shift
from discount to more premium products.
Page 1
The Fund @ Sprott | Equity Research
Page 2
Company Overview Altria Inc (MO) is a holding company which is currently the largest tobacco and
smokeless tobacco manufacturer in the United States. The company currently has 49.8%
of the US tobacco market through its subsidiary Philip Morris USA. Philip Morris USA
sells Marlboro, Virginia Slims, and discount brands such as Basic. Philip Morris
International (NYSE:PM) used to be also an Altria subsidiary until it was spun off in
2008. Apart from tobacco, other subsidiaries of the company include US Smokeless
Tobacco Co. (various smokeless tobacco products such as chewing tobacco), NuMark (e-
cigarettes), Michelle Wine Estates (Wine) and Philip Morris Capital Corporation
(Financial, primarily leasing). In addition, the company has a minority stake (27%) in
SABMiller Plc., a multinational brewing and beverage company based in UK with $91
billion in market cap. SABMiller was formed in 2002 when MO announced an agreement
with SAB to merge Miller Brewing Company into South African Breweries. MO received
430,000,000 shares or 36% of economic interest in SABMiller.
Industry Dynamics Declining Cigarette Sales Volume
USA faces significant governmental and private sector actions, including efforts aimed at
reducing the incidence of tobacco use and efforts seeking to hold PM USA responsible for
the adverse health effects associated with both smoking and exposure to environmental
tobacco smoke. These actions, combined with the diminishing social acceptance of
smoking, have resulted in a 3 to 4% average annual decrease in cigarette industry volume,
and we expect that these factors will continue to reduce cigarette consumption levels.
Consolidation and Restructuring
Tobacco companies have been able to overcome the industry decline and produce strong
cash flows by constantly consolidating operations and restructuring themselves to
eliminate unnecessary costs. As an industry who is limited to a small marketing and
promotion footprint by law, much of their business model tends to be cost driven. This
focus of restructuring operations and maximizing efficiencies has led to solid margins and
Valuation Altria has approximately 27% of the economic and voting interest of SABMiller plc
(“SABMiller”), which Altria accounts for under the equity method of accounting as
Altria's stake in SABMiller is less than 50%, and the company does not exercise control
over SABMiller. Altria is not allowed to fully consolidate SABMiller onto its balance
sheet, or to mark the stake up to its current value and can only record the book value of its
SABMiller holding on its balance sheet. Altria’s holding in SABMiller is currently
booked at $6.2 billion on the balance sheet. However, the current market value of the
holding is $25B. Altria has held SAB Miller stock for over a decade and would owe
massive capital gains taxes if sold today. Management has said they do not plan on selling
the stock for this reason and will continue to collect dividends from SAB Miller over the
long term.
In order to capture this value we have done two valuations, a DDM since many investors
are attracted to the high yield Altria offers as well as a modified DCF model. We have
altered our DCF to include the dividends Altria receives from their SAB Miller
investment. We have done this since these dividends are a recurring income for the
company and we do not expect Altria to sell the holding. Dividends have grown at a rate
of 8.5% over the last 5 years and we do not believe a material decrease in this growth rate
will occur. We forecast 7% growth in dividend income over the next 5 years.
2 stage DCF Model Assumptions recap: When discounting the company’s cash flows we used Bloomberg’s WACC of 7.1% to be more conservative as our self-calculated WACC of 6.06% was significantly lower. For a terminal growth rate we used 1%. With respect to debt issuances, we expect Altria to issue further debt in the future so as to cover its needs in cash. In addition, we expect Management to use its future COGS savings to continue rewarding shareholders through share-buybacks. As for CAPEX, we forecasted higher CAPEX for 2015 due to the manufacturing of the new USSTC facility. For the rest of the forecasted period we assumed lower CAPEX related to the smokeables and the non-smokeables segments and higher CAPEX related to the wine and the e-cigarettes segments. According to our 2-stage DCF Model Altria is 26.1% overvalued.
Dividends per Share $2.13 $2.30 $2.48 $2.68 $2.89 $2.12
YoY Growth 8.00% 8.00% 8.00% 8.00% 8.00% -26.73%
PV of Cash Flow $2.13 $2.13 $2.13 $2.13 $2.13 $31.89
Total PV per Share $42.54 Assumptions: Ke 7.90%
CV Dividend Growth 3.00%
DDM Model
Assumptions Recap: We used Bloomberg’s cost of equity of 7.9% instead of our self-calculated
cost of equity of 6.72% for the same reasons as in the DCF Model. We assumed terminal dividend
growth to be 3%. In addition, we assume that the company will grow at a rate of 1% and that
through share buybacks it will manage to grow its dividends by 3%.
Our DDM Model found Altria 12.7% overvalued.
Source: Bloomberg, Student Estimates
The Fund @ Sprott | Equity Research
Page 9
Investment Positives
Altria has a leading market share in an industry with inelastic product demand.
Strong growth in the e-cigarette and wine segments.
The company has a long history of paying large dividends and increasing them at a
high rate. Current dividend yield is 3.70%
A strengthening US economy and a decreasing unemployment rate could have a
positive impact on Altria as they could lead consumers to shift from discount to
premium products while also creating price increase opportunities for the company.
Due to its experienced management, Altria manages to operate efficiently and
increase its EPS even while having negative working capital.
As a mature business with a leading market share in two out of the four segments it
operates in, Altria has no need for high levels of CAPEX.
As a result of substantial debt restructurings the company’s interest rate has lowered
dramatically but is still high at a weighted average of 5.43%.
Investment Negatives
Minimal yoy growth in Altria’s key segment, cigarettes.
New pressures from the US government for FET tax increases related to all tobacco
products, even e-cigarettes.
Altria is overleveraged compared to its peers which could lead to future problems.
Dividend yield has been declining since 2003 reflecting the company’s high levels
of debt and poor growth prospects.
Upon completion of Lorillard's acquisition, Reynolds is expected to gain around 5%
market share on Altria.
Conclusion
Investment Recommendation
Sell, Target Price $44.64
In conclusion, Altria’s growth prospects are grim as the cigarette industry is declining,
the regulatory environment is tightening and competition is strengthening. We are confi-
dent in the future operations of Altria but at today’s current stock price ($52.50) Altria
is significantly overvalued using multiple valuation methods. Therefore we recommend
selling our position in Altria.
The Fund @ Sprott | Equity Research
Disclaimer This report was written by a student currently enrolled in a program at the Sprott School of Business. The purpose of this report is to demonstrate the investment analysis
skills of Sprott students. The analyst is not a registered investment advisor, broker or an officially licensed financial professional. The investment opinion contained in
this report does not represent an offer or solicitation to buy or sell any securities. This report is written solely for the consideration of this student managed investment
fund and should not be used by individuals to make personal investment decisions. Unless otherwise noted, facts and figures included in this report are from publicly
available sources. We cannot guarantee that the information in this report is 100 percent accurate, although we believe it to be from reliable sources. Information
contained in this report is only believed to be accurate as of the day it was published, and it is subject to change without notice. It cannot be guaranteed that the faculty or
students do not have an investment position in the securities mentioned in this report.