Shares of tobacco giant Altria (NYSE:MO) have taken a pounding in 2019 amid escalating headwinds in the e-cigarette market. Year-to-date, Altria stock is down 12%.
Recent weakness simply adds to what has been a secular decline in Altria stock, which dates back to mid-2017. The driver of this secular decline? A secular decline in tobacco use everywhere, which has weighed on Altria’s revenue and profit growth trajectories. From its mid-2017 highs, MO stock has shed nearly half of its value.
Contrarians and bulls will say its time to buy the dip in Altria stock. Their rationale? Traditional cigarette volume drops have been offset by price hikes, and this should continue for the foreseeable future. Meanwhile, today’s e-cigarette headwinds are temporary. Once they pass, Altria’s big Juul stake will continue to pay off in a big way. Even further, the cannabis market will gain traction over the next few years, and as it does, Altria’s big stake in Cronos (NASDAQ:CRON) will pay off in a big way, too.
That argument sounds good, doesn’t it? But it misses one big point.
Altria makes all its money from tobacco products, and without tobacco volume growth and with e-cigarette demand headwinds, this company’s revenue and profit growth trajectories will remain relatively muted. MO stock is appropriately priced considering those muted growth trajectories, and buying the dip in a fairly valued stock here — amid a potentially catastrophic e-cigarette crisis — doesn’t seem like the smartest move.
The investment implication? Steer clear of Altria stock for now. Wait for the stock to get cheaper. Wait for the headwinds to clear. Then, if the price is right, buy the dip.
Altria’s Secular Growth Prospects Aren’t Great
In the big picture, Altria’s secular growth prospects are pretty dour. This is an antiquated tobacco giant, operating in a world where tobacco usage is in a secular decline. Plus its largest potential catalysts (e-cigarettes and cannabis) face existential crises.
None of that screams healthy revenue or profit growth.
First, and foremost, Altria makes 95% of its revenue from either smoking or smokeless tobacco products. Demand for these products is dropping as consumers are increasingly becoming more aware, healthier and active. Consequently, 95% of Altria’s revenues will suffer from volume drops over the next few years. Sure, those volume drops can be offset somewhat by price increases. But, declining volumes imply that Altria’s big tobacco business is essentially a no-growth business.
Second, Altria’s big e-cigarette tailwind has turned into a massive headwind. Specifically, the Centers for Disease Control and Prevention and the U.S. Food and Drug Administration have opened an investigation into e-cigarettes as over 1,000 lung injury cases and 18 deaths related to e-cigarettes have been reported. About 80% of these cases deal with consumers under the age of 35. The median age is 23. The youth are at stake here.
The vaping crisis is now a political hot topic — the states of Michigan, New York and Massachusetts have already banned the sale of e-cigarettes. San Francisco has done the same and Los Angeles is on the brink of a similar decision.
I don’t see these headwinds easing up anytime soon. This isn’t a near-term phenomena. People are paying attention, and because it’s impacting the youth, people will act. They already are. These actions will have long-term consequences, including depressing what was a red-hot Juul growth narrative.
Altria is one part no-growth tobacco business and one part cooling off e-cigarette business. That’s not a great combination.
Altria Stock Is Priced Appropriately
Considering its muted growth prospects, Altria stock is priced appropriately at the current moment.
Many investors look at the stock’s 10-times forward price-to-earnings multiple and think that the stock is too cheap for its own good. But, the average tobacco stock trades at just 11.5-times forward earnings, so the stock’s 10-times forward multiple isn’t too far off from the tobacco stock norm. At the same time, if you model out Altria’s forward earnings growth trajectory, it becomes clear that MO stock shouldn’t fetch much more than a $40 price tag today.
Here are then numbers. Smoking and smokeless tobacco volumes will likely continue to decrease by 3%-5% over the next several years. Those declines will be somewhat offset by roughly 5% price hikes on tobacco products. Thus, the tobacco business should eek out narrow revenue gains over the next few years. Meanwhile, margins in that business should remain relatively stable, as loss of demand and increase in unit prices should have an offsetting impact on one another in terms of the bottom line.
At the same time, Juul and Cronos will continue to add to the bottom line, but in a less meaningful way than previously anticipated.
Taking all this into consideration, my modeling pegs Altria’s fiscal year 2025 earnings per share at $6. Based on a tobacco stock average 11.5-times forward earnings multiple and a 10% discount rate, that equates to a FY19 price target for Altria stock of roughly $43.
Bottom Line on MO Stock
By my numbers, Altria stock looks like a fairly valued stock today. But, Altria stock is also facing significant optical headwinds from the e-cigarette crisis.
A good rule of thumb in investing — don’t buy fairly valued stocks with big optical headwinds. Instead, if a stock has big optical headwinds, only buy it at a discount to fair value.
Thus, I’d steer clear of MO stock here and now. If it dips below $40, that’s a different story. But, for now, Altria stock doesn’t look too compelling.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.