Altria Group (NYSE: MO) controls over 50% of the cigarette market and its smokeless products are quickly growing in popularity. The company has adapted well to stricter legislation against the tobacco industry and to anti-smoking campaigns by various interest groups. In 2014, Altria had revenue of $24.52 billion, dwarfing its competition in the tobacco industry.

On November 4, 2015, the Illinois Supreme Court ruled 4-2 to overturn a decision by the Illinois 5th District Appellate Court to award plaintiffs $10.1 billion in a class-action lawsuit alleging that Altria’s Phillip Morris subsidiary lied to cigarette smokers about the dangers of smoking ‘light’ or ‘low-tar’ cigarettes. The original lawsuit represented 1.4 million smokers in Illinois and was thrown out by the Illinois Supreme Court in 2003 but later retried in 2014 after an appeal. In the latest ruling the Illinois Supreme Court noted that the appellate court does not have the authority to overturn the decision of a higher court.

On 10/29/2015, Altria reported 3Q15 financial results for the three months ended September 30, 2015. The company had $6.70 billion in net revenues, up 3% from $6.49 billion in the year-ago quarter, helped by an increase in tobacco product prices. Its Phillip Morris subsidiary accounted for about 51% of cigarette sales while Marlboro accounted for about 44%. Smokeable and smokeless products revenue each increased 3% while wine revenue increased 9% in the quarter. And although the company saw a rise in expenses and costs, that did not hurt operating margins of about 61%. The company reported operating income of $2.31 billion for Q3 2015, up 15% from $2.00 billion in Q3 2014. For 3Q15, Altria reported net earnings of $1.53 billion, or $0.78 per share, representing a year-over-year increase of 9.4% from $1.40 billion in 3Q14.

Management reaffirmed full-year 2015 guidance with earnings per share in the range of $2.76 – $2.81, representing annual growth of 7.5% – 9.5% over full-year 2014 earnings per share of $2.57.

As of market close on November 6, 2015, Altria shares were at $57.08, slightly below the high-end of the company’s 52-week range of $47.31 – $61.74; Altria shares were 0.5% below its 50-day moving average of $57.37 but 7% above its 200-day moving average of $53.37. Year-to-date, shares are up about 16% after a strong rally since mid-June 2015. Shares trade at 21.5x earnings.

RBC Capital downgraded Altria from an Outperform rating to a Sector Perform rating but increased its price target from $60 to $62 on near flat sales at its lead brands slowing growth in the short term but with potential earnings per share upside of 4% – 6% from the Anheuser-Busch InBev (BUD) and SAB Miller merger (Altria holds a large stake in SAB Miller). Altria has an average consensus analyst price target of $64, 12% higher than the company’s most recent closing price.

In August 2015, Altria’s Board increased the company’s quarterly dividend by 9% from $0.52 to $0.565. In the last 46 years, the company’s Board has approved 49 dividend increases. In 3Q15, Altria paid out $1 billion in dividends bringing its total dividend payout to $3.1 billion for the nine months ended September 30, 2015. Management has a target dividend payout ratio of 80% of earnings per share. Altria offers an annualized dividend of $2.26 and a dividend yield of 4%.

In the third quarter of 2015, Altria’s Board also approved the repurchase of 5.2 million shares worth $263 million. This used up all remaining funds under the company’s $1 billion share repurchase program from late 2014. The company’s Board announced a new $1 billion share repurchase program which management expects to use entirely by year-end 2016. From 2007 to 2014, Altria has lowered the amount of shares outstanding from $2.12 billion to $1.98 billion.

In the third quarter, Altria beat analyst estimates on revenue by about 2% but reported in-line EPS. The company has beaten earnings estimates in three of the last four quarters. Analysts expect a modest increase in cigarette spending tied to an improving U.S. economy, lower unemployment and slumping gas prices that should increase discretionary spending. However, higher cigarette prices tied to tax increases could counteract this and hurt Altria. The company is aware of the backlash against tobacco products and is diversifying its offerings as more people switch from cigarettes to e-vapors (which have also faced criticism tied to toxic second-hand smoke).

Consumers responded will to the launch of the Markten XL and expansion of the Green Smoke product line in early 2015, and the company is looking at tobacco innovation through research and development spending, while boosting marketing and advertising of these new products. In addition, the company has diversified into alcoholic beverages.

For the first nine months ended September 30, 2015, Altria had operating cash flow of $4 billion and only spent $162 million on capital expenditures, leaving the company with about $3.9 billion in free cash flow (20% of sales).

Since 2009, Altria has steadily increased its dividend payment but the company’s dividend yield has dropped over the same time period as its share price rose – giving investors a boost in dividend income and handsome capital appreciation. In 2009, Altria shares traded at a price-to-earnings ratio of about 15x but this ratio jumped to about 23x in 2014, which drove down its dividend yield.

Altria has a low price target of $62 and a high price target of $66, representing price appreciation upside of 9% – 16%. Analysts estimate Altria will have a P/E ratio of about 21x for 2015 and about 19x for 2016. An increasing share price but decreasing P/E ratio suggests analysts expect strong earnings growth.

 

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