Most know about the terrible facts about tobacco use. This has led to depressed valuations for tobacco companies in almost all of the times. This means that if you can reinvest those fat dividends at low valuations, your future returns have a very high chance of being pretty good.
Governments need tobacco companies, because it provides them with a healthy stream of revenues through excise taxes for example. Furthermore, it is much more popular to tax the evil tobacco conglomerates, rather than increase taxes on middle class voters, or reduce education expenditures for high-schools
The positives behind companies like Altria includes strong brand loyalty, the fact that consumers are addicted to the product, efficiencies of scale and strong pricing power. It would be almost impossible to start a competing tobacco company today, because of the ban on advertising.
However, the emerging opportunity and threat are e-cigarettes. It seems that these are advertised, and could convert a portion of regular smokers to e-cig smokers. Unfortunately, e-cigarettes could be more disruptive than regulation threats, and they carry slimmer margins. On the positive side, for those legacy tobacco companies that are building up their e-cigarette business, this could be a growth kick to their otherwise stable tobacco revenues.
Plus, I would not be surprised if advertising of e-cigarettes reminds consumers about regular cigarettes, thus leading to increase in tobacco consumption. Most recently Phillip Morris International and Altria created an agreement to exclusively commercialize two of Altria’s e-cigarette products outside the U.S.. At the same time, PMI will make available to Altria two of its heated tobacco products for sale in the US.
Recent news about CVS (CVS) dropping tobacco products from its stores may have upset some investors, but those headlines are an example of investment noise out there. It is noise because consumers who were used to purchasing tobacco products at CVS would likely take their business elsewhere.
Of course, the real risk is if other retailers follow suit, and decide to stop selling tobacco products altogether. I see this scenario having a very low likelihood however, since these retailers could lose out not only on tobacco revenues but on incremental revenues that tobacco customers bring with them. For example, if you buy your gasoline at the place that you also buy your pack of cigarettes, you might simply take all of your business elsewhere if your Marlborough is not available.
For Altria, it has a dominant position in the US tobacco market with Marlboro brand having a very loyal following amongst smokers. The sheer scale of operations allows Altria to exert higher influence on vendors and distributors. The company is also a leader in US the smokeless market, with a 50%-55% market share. The smokeless tobacco segment is expected to generate single digit volume growth.
Currently, this dividend stock champion sells for 16.10 times earnings, yields 5.30%, and has a high payout ratio. Given the economics of the business, and the expectation for future earnings growth in the mid single digits, I find it attractively valued today. I plan on adding to my position in the company sometime in 2014, subject to availability of funds.
Full Disclosure: Long MO, PM, KRFT, MDLZ