It’s fair to say the tobacco industry is facing something of an existential crisis right now. Cigarettes are wildly out of fashion today, while smoking has been labeled the number one public health enemy across much of the developed world.
A Great Dividend – But Will It Last?
From a traditional income investor’s perspective, Altria’s dividend ticks almost every single box.
For example, its distribution has been increasing at a compound annual growth rate of 7.70% over the last half-decade, while its forward yield stands at an industry-busting 8.49%. Moreover, the company has been paying out – and raising – its dividend for 53 consecutive years, making it one of the most reliable income streams to be found anywhere on the market.
However, MO’s payout ratio is worryingly high at 76.6%, which suggests the firm might have difficulty maintaining its unbroken streak of dividend payments.
Nevertheless, in spite of Altria’s worsening safety profile, it is developments in the secular realm that could make the business come unstuck. The number of smokers is fast declining, and it’s safe to assume this trend will continue.
In fact, it is only because demand for addictive products like cigarettes is so inelastic that MO is able to keep on upping its prices, thereby buoying its profits artificially period after period. Indeed, adjusted earnings per share rose 4.9% for the company in the third quarter, while net revenues fell by 3.5% during that time.
A situation like this is far from ideal – and investors would be wise to take a cynical view on how things will unfold.
That said, Altria’s dividend is vital to its ongoing viability as a functioning business, with shareholder support an extremely important source of funds for the enterprise. Therefore, there are serious incentives for the firm to keep its distribution track record intact, making MO’s dividend – for the short-term at least – as safe as it is generous.
Is The Emerging Cannabis Sector A Growth Catalyst?
Driven by the increasing acceptance of cannabis for medical and recreational use, the legal cannabis industry is a rapidly growing market that’s expected to reach $198 billion by 2028.
Indeed, Altria has been exploring opportunities in the legal cannabis industry as a potential new source of revenue over the last few years. For example, it made a $1.8 billion investment in Canadian marijuana company Cronos in 2018, a move that allows MO to potentially capitalize on the growing appetite for cannabis-related products.
However, it’s not at all clear that the Cronos play is going to plan. In a recent move, Altria abandoned its expiring warrant from the original deal, giving the impression that the company had gotten cold feet over the partial acquisition.
In fact, that’s not surprising: the warrant was exercisable at a price of CAD$19.00 per common share up until early March this year, whereas the stock was changing hands at CAD$3.81 the day Altria abandoned the warrant.
Furthermore, the legal cannabis industry has been lauded as a potential revenue stream for legacy tobacco firms like Altria, although there are several further headwinds that may impede their ability to fully exploit this burgeoning market.
One key challenge is the poor reputation of so-called “sin stocks,” which may pose a significant challenge for firms looking to enter the industry. Historically, these types of companies have been subject to negative press and public scrutiny, and the cannabis industry may be seen as a continuation of this trend, resulting in enhanced reputational risk for firms navigating through the space.
Where Will Altria Be In 10 Years?
Tobacco companies will likely face increasing pressure in the form of anti-smoking regulations over the coming decade, with competition from businesses touting alternative smoking products such as e-cigarettes and heat-not-burn devices.
Indeed, higher taxes and advertising bans have been shown to be effective in reducing smoking rates, and are likely to continue to be implemented in many countries. This could lead to a decrease in demand for traditional cigarettes, which would negatively impact MO’s bottom line.
Besides, alternative smoking products – which are perceived as less harmful than regular cigarettes – have been gaining in popularity in recent years, with vaping being widely adopted by young people of late. However, there is still ongoing debate about the safety of these substitute devices, with some places banning the newfangled alternatives, while others have embraced them as a less harmful replacement for that which came before.
And finally, it’s also possible that tobacco companies will look to diversify their businesses and enter into other markets to offset the potential decline in traditional tobacco products.
Altria is already doing this with its roughly 10% stake in the world’s largest brewer, AB InBev. This will provide MO with substantial income and cash flow – two things it will sorely need if it’s to keep on paying its highly sought-after dividend.
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