Summary
- Altria's tobacco products performed well in the first COVID-19 quarter.
- The company is a leader in non-combustibles, giving it some long-term footing, and it's a product portfolio that also performed well in the COVID-19 environment.
- There are concerns around the company's US-centricity and the quality of its equity investments.
- Nonetheless, Altria has some strong brands and continues to generate lots of cash even now, making it an attractive pick.
Altria (MO) had a strong quarter, where for the first time in years COVID-19 was able to stem the decline in the cigarette business by keeping stressed people idle at home. We were not surprised that the results of this Dividend Aristocrat would be of some quality, with strong performance across almost all segments. The only underperformers were its vaping and e-cig products, which were hampered by delayed commercialisation efforts and regulatory headwinds. Overall, we think that Altria is attractive due to its strong non-combustible portfolio, giving it an out for the long term, and the attractive cash generation that we can expect to continue even in this challenging environment. For that reason, we think that this is an appropriate pick for income investors.
(Source: Altria Q1 2020 Presentation)
The Positives: Resilience
In the most recent quarter, Altria proved its resilience with 18.5% growth in EPS, driven primarily by volume. For the first time in a while, the COVID-19 environment afforded Big Tobacco a reason for stemmed decline in smokeables after years of a continued secular downturn. Essentially all smokeable products saw substantial growth, including Middleton Cigars, which grew at 13% in volume, and deep discount cigarettes, which grew at 14.4%.
Although some of this growth was provoked by tailwinds in e-cigs, where negative publicity might have had people switch back to smokeable options, much of the volume growth is a consequence of pantry loading. This is a trend that's become quite familiar in the COVID-19 environment in food staples companies like Danone (OTCQX:DANOY) and Unilever (UL), and now it's manifested in tobacco with trips to the tobacco shop happening on more of a weekly rather than daily basis. For the moment, this stocking activity has front-loaded sales into the Q1, but management has not yet seen any evidence that total purchases are changing. So, we take the pantry loading as evidence of the importance of these products to their markets and can predict resilience forward.
Another pleasant development was the volume growth in the non-combustible portfolio as well. This portfolio is a critical prong of Altria's long-term strategy, as although regulated, the social stigma around non-combustible products is less pronounced, mainly because the use of the products is less obvious. This is especially critical given Altria's US-centric presence, where anti-smoking sentiment is very pronounced. Indeed, non-combustibles have succeeded in other countries where a progressive distaste of smoking is prominent, like with snus in the Nordic countries.
(Source: Altria Q1 2020 Presentation)
Overall, robust portfolios should sustain the selling point of this issue, which is its juicy dividend. With a reasonable leverage of 2.3x EV/EBITDA and a fair payout ratio on net income of ~80%, Altria's dividend is not in peril with respect to its incoming obligations related to Juul. With limited downside risk on the business, even in a recessionary environment where the inelasticity of tobacco products should hold true now as they always have, we can expect that this Dividend Aristocrat can keep up its run to 55 consecutive annual dividend increases.
