Altria, A Beaten Down Sin Stock

Normally, I wouldn’t like to invest in a stock like Altria, because I tend to be socially conscious and smoking isn’t something I support. However, as a capitalist, it’s hard to deny that MO is probably good value for the money even with its latest financial struggles.

Risks

Ultimately, smoking is falling in most developed countries as there are significant anti-tobacco campaigns in most parts of the world. While smoking is declining fast, e-cigarette usage is growing fast and MO has taken a 25% stake in e-cig company JUUL. Additionally, MO has invested in the growing Marijuana market to take advantage of the decriminalization trend occurring in the US and globally. Revenues declined over the last year as a result of some these trends, but management expected this and has put in place a plan to start growing again soon.

Valuation

We typically start with the Dividend Discount Model for our dividend growth investments:

5 Year Dividend Growth: 6.49%

Trailing 12 month Dividends: 3.20

Cost of Equity: 8%

Value = 3.20 * (1 + 6.49%) / (8% – 6.49%)

Value = 225.67

There’s obviously something going wrong with this model! Taking a quick glance at Altria’s stock price says we’re missing something. And this points out a shortcoming of the Dividend Growth Model: When dividend growth is close to or exceeds the Cost of Equity, then the model does not work. Price will approach infinity as growth comes close to the cost of equity. So let’s take another look and assume a lower terminal dividend growth rate close to inflation.

5 Year Dividend Growth: 3%

Trailing 12 month Dividends: 3.20

Cost of Equity: 8%

Value = 3.20 * (1 + 3%) / (8% – 3%)

Value = 65.92

Much better! Using this model, at the current price of around $50, MO is about 30% undervalued. There is likely a bit more discounting of the growth rate going on in the markets given MO’s struggles for growth so I’d consider MO close to fairly valued.

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