Altria: Forever Stock No. 2

Altria
(NYSE:MO)
Blowing Smoke Rings around the Competition
F O R E V E R S T O C K N O . 2

Few industries are more widely disliked than
tobacco. While the industry has remedied many of
its bad business practices in recent decades - in part
because of civil and government
lawsuits - it continues to have a
sour reputation.
A HATED INDUSTRY

It’s a plain truth that many investors shun
tobacco investments on moral grounds. They
simply refuse to invest in tobacco
companies because of their negative
feelings toward the industry.

And that’s fine if morality is a factor in the
investment decision process. However, for those
interested in turning this hated industry into an
opportunity for safe and steady income, I encourage
you to read on.
SAFE & STEADY INCOME

large companies with huge economic “moats,”
brands that are dominant around the world, healthy
balance sheets, recession-proof products, and safe
and steady dividends are where you want to be
invested. These types of companies can weather a
storm better than the competition, and can provide a
decent return in a low-yield world.
In today’s volatile stock market,

The world’s premier
tobacco company is Altria
(NYSE:MO). You know
Altria best for its Marlboro
cigarette brand, one of the
most widely recognized
and valuable brand names
in the world. In fact,
Millward Brown, a global
market research agency,
estimates the world market
value of the Marlboro
brand at $69.4 billion,
putting it in the top 10.

Because of market penetration and pricing power. Philip Morris
USA, Altria's cigarette segment, commands 50% of the U.S. market.
Total market penetration for Marlboro alone is 42%, while Altria's
lesser-known brands - Merit, Virginia Slims, Parliament, and Benson
& Hedges – comprise the remainder.
Why is Marlboro so highly prized?

Prior to 2007, Altria was a massive conglomerate. In addition to its
cigarette business, Altria owned Kraft Foods, the second largest packaged
food company in the world, as well as Miller Brewing. Altria sold a
majority interest in Miller to South African Brewers in 2002 (Altria still
retains a 27% stake). Kraft was spun off to Altria shareholders, who in
2007 received 0.68 shares of Kraft stock for every Altria share.
A MASSIVE CONGOLMERATE

Altria is particularity adept at focusing on the domestic
tobacco business. In March 2008, it spun off its
international cigarette operations as Philip Morris
International. In the deal Altria stockholders received one
share of Philip Morris for each Altria share.
While these sales and spin-offs shrank Altria's size by
more than half, they cleared the way for management to
focus on the still-lucrative domestic tobacco market. And
for shareholders, these moves have helped to unlock
value.
ADRESSING THE DOMESTIC FRONT

The real economic value of a powerful cigarette
brand like Marlboro is its price inelasticity - a
consumer's perceived value of the product doesn't
significantly decline as the price rises. This allows
Altria to more easily pass ever-rising sales and excise
taxes on to consumers.
THE KEY TO SUCCESS

It's no secret that overall cigarette consumption is on the decline. Rising prices
obviously play a part, but the decline has just as much, if not more, to do with the
growing consciousness surrounding smoking's health risks. Governments have also
aggressively discouraged tobacco consumption through high excise duties and
legislative controls.
AND OF COURSE THERE ARE HEALTH RISKS...

A $1 billion e-cigarette industry has emerged to help
offset the decline in use, giving Altria an alternate
market to capture. E-cigs, as they are called, are
battery-operated and marketed as tobacco free
products and a “healthier” smoking option. Altria
estimates that 90% of adult smokers are aware of
them and about two-thirds have tried them.
However,

Although Altria’s Nu Mark subsidiary was the last of the big tobacco
companies to enter the market, it first tested its MarkTen brand of
e-cigs in late 2013 and plan to expand the brand in late 2014. Altria
depends primarily on pricing power to counter the consumption
slide - profit margins are maintained through price increases.
BRAND EXPANSION

This isn't to say that there aren't pockets of
growth in the tobacco industry.

In late 2007, Altria acquired John Middleton Inc., a leading
manufacturer of machine-made large cigars for $2.9 billion.
Middleton's principal brand - Black & Mild - is the second
largest selling machine-made large cigar in the U.S.

Altria's greatest growth potential now likely resides in smokeless tobacco,
a niche market posting 7% annual revenue increases over the past few
years. To compete in the growing smokeless tobacco market, Altria
acquired UST Corp., the world's largest smokeless tobacco company, and
its formidable brands - Copenhagen, Skoal, and Red Seal.
Now called U.S. Smokeless Tobacco Co., the company recently announced
plans to build a $118 million, 230,000-square-foot facility in Kentucky to
expand production. The facility is expected to be operational by 2016.
THE FUTURE OF SMOKING

From early 2000 to the present, Altria's stock price has
appreciated at around a 15% average compounded annual
growth rate. Tack on an average dividend yield of 5% or so
(the current yield is 5.3%), and you’re looking at a more-than-
impressive 20% average annual return.
Despite being near the top of many investments to avoid,
despite experiencing a continued drop in domestic
consumption, and despite higher “sin” taxes, Altria’s stock
price has managed to increase six-fold since early 2000.
20% AVERAGE RETURN

By spinning off or selling various business units
and acquiring others in key niche markets, Altria’s
management has successfully overcome onerous
regulation and bad publicity. And it’s returned a
healthy dividend to boot.
A HATED INDUSTRY

That kind of long-term success doesn’t
happen by accident. If you don’t mind the
business model, holding Altria for the long
term should be a winning strategy. Where
there’s smoke, there’s profit … at least with
Altria.
WHERE THERE’S SMOKE, THERE’S PROFIT

Ready for more?
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Altria: Forever Stock No. 2

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