One of the Big Tobacco companies, Altria MO offers a lucrative dividend yield to income seekers today. Although Altria operates in a declining industry, we award it a wide economic moat rating, as we expect it to outearn its cost of capital over the next 20 years. 

Altria is the leading tobacco manufacturer in the United States. In fact, with Philip Morris International owning the international rights to Marlboro, the U.S. is currently Altria’s only market, resulting in more concentrated regulatory risk than for the other major tobacco players, which are multinational. We think it is logical, in the face of that risk, that Altria is pursuing a multiprong approach to cigarette substitutes, even though we harbor doubts about the long-term profitability of some of the emerging categories. Although it is in secular contraction, the U.S. cigarette market is a relatively attractive one. We forecast the medium-term volume decline rate of the U.S. cigarette to be around 5% per year, which implies a recovery from the high-single-digit declines of recent years, due to the receding of the competitive threat from vaping. However, the ability to consistently price above the rate of volume declines should ensure that Altria can continue to increase its revenue, earnings, and dividend.

Key Morningstar Metrics for Altria

Fair Value Estimate

: $52

Star Rating^: 4 Stars

Economic Moat Rating

: Wide

Uncertainty Rating

: Medium

Economic Moat Rating

An addictive product and almost insurmountable barriers to entry in the tobacco industry form strong intangible assets and give Altria a wide economic moat, in our opinion. Tobacco contains nicotine, an addictive substance that suppresses the cessation rate. According to data from the Tobacco Atlas, more than 60% of all smokers intend to quit, and 42% have attempted to quit over the past 12 months. Yet in most markets, the smoking rate is in only a very modest decline, implying that the majority of smokers attempting to quit fail to do so. The addictive nature of the product forms a powerful competitive advantage when combined with very tight government regulation that over the years has served to damp market share volatility and competition on price. In the U.S., the Food and Drug Administration has imposed restrictions on marketing new or modified products that essentially keep new entrants out of the market. Even if new entrants were to receive FDA approval for a new product, severe restrictions on advertising make it difficult to build market share.

Fair Value Estimate for Altria Stock

Our $52 fair value estimate implies a forward price/adjusted earnings ratio of 11 times, forward enterprise value/adjusted EBITDA multiple of under 10 times, and nearly 7% dividend yield. Our base case is predicated on the assumption of a continued decline in cigarette volume at an annual rate of 5%, offset by continued strong pricing. We expect a five-year revenue compound annual growth rate of 1.5%, fading throughout our forecast period. This growth rate assumes modest contributions from vaping and heated tobacco, which we expect to be commercialized within the next two to three years. We forecast Altria’s normalized operating margin to fade from the current mid-50s to 51% in the steady state, well below the near 58% margin achieved in 2022, due to operating deleverage and the negative mix effect of vaping and heated tobacco growth.

Risk and Uncertainty

Investors in tobacco companies, particularly those holding shares in a single-market pure play like Altria, should have the stomach for fat-tail risk. The shifting sands of regulation have created some new risks to Altria’s business model in recent years. Litigation risk still remains, but adverse judgments have been manageable recently. While it is almost impossible to forecast the magnitude of any awards against the tobacco industry, we expect payouts to be within Altria’s annual free cash flow. The U.S. ban on flavored nicotine liquids and the current plan to ban menthol cigarettes demonstrate that the FDA is willing to take significant steps to prevent the uptake of nicotine products by new consumers. We estimate that 20% of Altria’s revenue and operating profit is generated in the menthol category, although it is likely that most menthol consumers would switch to nonmenthol if the ban comes to fruition. The potential for limits on the nicotine levels in cigarettes is a relatively new risk. We do not believe such controls are a foregone conclusion, however, because they could have unforeseen consequences such as increasing cigarette volume.

Altria Bulls Say

  • The U.S. market, while mature in volume terms, is a highly affordable one relative to other developed markets. This leaves headroom for price increases for many years.
  • Altria has kept its options open. It has a broad suite of cigarette alternatives in its portfolio that should ensure it holds a leadership position in whichever categories are victorious in attracting smokers to new products.
  • Relatively low capital requirements allow the company to return significant capital to shareholders in the form of an 80% stated dividend payout ratio policy.

Altria Bears Say

  • Altria lacks exposure to some of the emerging markets in which total tobacco consumption is increasing, leaving it open to the secular decline rate that we estimate to be around 5% per year.
  • The FDA appears to have taken a more aggressive approach to cigarette regulation in recent years. It is examining a ban of the use of menthol and a lowering of nicotine in cigarettes.
  • With cigarette volume in secular decline, multiple alternatives are emerging, limiting the scale and profitability potential of each emerging category.

This article was compiled by Susan Dziubinski and Sylvia Hauser, and originally appeared on the Morningstar US website.

^ What do the different star ratings designations mean?

5 stars indicates an investment idea with a high probability of significant risk-adjusted appreciation from the current market price during a multi-year time frame. Scenario analysis developed by our analysts indicates that the current market price represents an excessively pessimistic outlook, limiting downside risk and maximizing upside potential.

4 stars indicates that appreciation beyond a fair risk-adjusted return is likely.

3 stars indicates that investors are likely to receive a fair risk-adjusted return (approximately cost of equity).

2 stars indicates that investors are likely to receive a less than fair risk-adjusted return and should consider directing their capital elsewhere, in our opinion.

1 star indicates a high probability of undesirable risk-adjusted returns from the current market price over a multi-year time frame. Our scenario analysis indicates the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.