After following Altria for almost three years now, I think I may have been a little too optimistic on some points related to regulation, competition and growth potential.
Regulatory headwinds have been much stronger, putting pressure on the legacy cigarette business and the development of new products (e.g. vaping). Besides, there is a solid social trend favouring a healthy lifestyle.
Competition in the non-smoking segment remains very strong, with both small and global players offering alternative products.Future returns from owning Altria will likely be lower
If you buy and sell a business for the same valuation multiple (e.g. 10x PE or 8% dividend yield), then your return from owning the stock equals the sum of a dividend yield and the growth of that dividend. In the case of Altria now, it is a 6.5% dividend yield and about 5-6% annual growth, which equals 11.5-12.5% total shareholder return, significantly less than the 20% annualised return achieved since October 2019.
Despite this, I prefer to keep Altria's position for now. The two key drivers for such decisions are:
- Company’s ability to pass on inflation
- Alternative opportunities to switch from Altria
Selling the stock now and paying a capital gain tax would leave me with cash that will lose its purchasing power over time. If I reinvest it into another business, I have to make sure it generates better returns. Returns have to be high enough to compensate me for the tax I would pay after selling my Altria position.Inflation hedge?
As for inflation, in theory, Altria has a good chance to pass the rising inflation to consumers due to its 50% market share, strong margins, low capital intensity and a very loyal consumer base. However, it is not going to be easy. Consumer income was boosted by a one-off COVID-related support programme in the US. Lower mobility also reduced options for consumer spending and indirectly benefited tobacco consumption.
The big question is whether now, faced with the rising cost of living, especially fuel prices, consumers would maintain their spending on tobacco or whether they would cut back.WSJ
has recently published an article
arguing that inflation will negatively impact tobacco companies. Most smokers are in a low-income category and are more sensitive to rising fuel prices than wealthier groups. Besides, 60% of cigarettes are sold at fuel stations. Higher prices at the pump discourage impulse spending in gas station convenience stores. Even if total tobacco consumption does not fall too much because of inflation, consumers could trade down, which would negatively impact sales of premium brands like Marlboro (Altria) with a consequent impact on the bottom line (Marlboro is a higher margin product than discount cigarettes).
The company is scheduled to publish its first-quarter results on 28 April, and I am keen to see what impact inflation will have on its performance.
Notably, the management of Altria has already seen some negative impact from inflation earlier this year. This means that the guidance they provided (4-7% EPS growth in 2022) should reflect some inflationary pressure and a high base effect of 2020-2021. The risk, of course, is that inflation has significantly accelerated after the call with the rising energy prices, which management could not have fully anticipated. I will view it positively if they deliver growth at the lower end of the guidance range. The company has some leeway with regard to R&D and marketing expenses, so perhaps in a weaker macro environment, they could adjust their spending plans.
This is what the CEO, Billy Gifford, said at the latest earnings call on 27 January 2022: