What’s more attractive to an income-oriented investor than a high-dividend-yielding stock? It’s probably a stock that has a reputation for increasing its dividend. And what better than a stock with a growing dividend? Many yield-oriented investors would tell you that this is a stock with a growing high-yield dividend that has achieved Dividend King status.
The kings of dividends are S&P500 stocks that have increased their dividend payments every year for at least 50 consecutive years. A qualifying stock has been successful in generating excess revenue in all kinds of macro environments, including multiple recessions, bear markets, high rates of inflation, and even stagflation. Dividend Kings have earned a reputation for stable and growing income over time and are sought after investment options.
The tobacco company Altria Group (MO 1.29%) deserved this distinction. But he’s also earned some ill will for the now-controversial products he makes and sells. Should income investors buy the stocks? Let’s take a look at its fundamentals and valuation and see if we can find an answer.
Huge share buybacks drove up profits
On July 28, the owner of the top-selling cigarette brand in the United States, Marlboro, shared its financial results for the second quarter.
Altria Group posted net sales of $5.4 billion in the second quarter, down 4.3% from a year earlier. However, this drop is worse than it looks because it does not take into account the sale of the company’s wine business, Ste. Michelle Wine Estates, last October. Adjusted for this event, Altria Group’s net revenue fell only 1.4% year-over-year. The company’s net revenue declined due to a 10.9% decline in volumes in the smoking products segment to $22.9 billion for the quarter. This includes Marlboro cigarettes and black and mild cigars. With its 48.2% retail share of the US market, Altria Group was able to largely offset this drop in volume with price increases. Net revenue for the segment fell just 0.7% year-over-year to $4.7 billion in the second quarter. The only reason revenues did not rise slightly for the segment was inflationary pressures on consumer disposable income.
In the oral tobacco products segment, net revenue decreased 3.8% year-over-year to $633 million. Volume declines in high-end brands Copenhagen and Skoal could not be offset by gains in the oral nicotine sachet called!, causing segment volume to fall 4.4% from a year-on-year to 208 million cans and packages. Price increases were only able to partially offset the decline in volumes.
Altria Group recorded non-GAAP (adjusted) diluted earnings per share (EPS) of $1.26 in the second quarter, equivalent to a growth rate of 2.4% over the prior year period. A 0.2% drop in net profit to $2.3 billion in the quarter was more than offset by a 2.2% reduction in its number of shares outstanding to 1.8 billion.
As inflation eventually subsides and consumers once again have more disposable income, Altria Group is expected to return to marginal revenue growth. Combined with the share buybacks it has the capital to execute, that explains analysts’ annual adjusted diluted EPS forecast of 4.3% for the next five years.
A sizzling dividend with room for growth
Altria Group posted a dividend yield of 7.9%, more than five times the S&P500 return of 1.5% of the index. Still, the dividend is very durable.
This is supported by the fact that the Altria Group’s dividend payout ratio is expected to be around 75% in 2022. For context, it is moderately below the company’s target payout ratio of 80%. This gives the Altria Group plenty of capital to buy back shares, make acquisitions and pay down debt.
The stock is significantly undervalued
Altria Group is a quality company. And it looks like the stock is being overlooked by the market.
In fact, Altria Group’s price-to-earnings (P/E) ratio of 9.4 is well below the tobacco industry’s average P/E ratio of 13.2. To be clear, the market is right to be concerned about the company’s future.
The relation between Philip Morris International and Altria Group, in which the latter distributes the non-burning tobacco product IQOS in the United States, is in danger. It would be one less growth avenue for the company. But its 10% stake in Anheuser-Busch InBev worth more than $10 billion should provide Altria Group with options to remain relevant for many years to come. This is what makes the Dividend King a great buy for income investors.
Kody Kester has positions in Altria Group and Philip Morris International. The Motley Fool recommends Anheuser-Busch InBev NV and Philip Morris International. The Motley Fool has a disclosure policy.