As markets continue to trade near all-time highs, it is relatively challenging to find attractively valued or undervalued stocks. Altria (MO) is one stock that might be worth considering from a valuation perspective.
On Jan. 28, Altria reported results for Q4 2020 and provided guidance for FY2021. The company expects earnings per share for the current year of $4.56 (mid-range of guidance), with the stock’s most recent closing price at $44.29. MO stock is therefore trading at a forward P/E ratio of 9.7. Given the broad market valuation, the stock looks attractive at current levels.
However, the potential for capital appreciation is not the only reason to like Altria. The company has an annual dividend pay-out of $3.44, which implies a dividend yield of 7.77%. Dividends are sustainable considering the company’s cash flow potential.
Before looking at the business developments, there is another factor that makes MO stock attractive. The stock has a beta of 0.62. While the outlook for the market remains bullish, a near-term correction seems imminent and exposure to low beta stocks could help with capital preservation.
In terms of the stock’s price action, Altria has risen 4% over the past year and is up around 8% year-to-date. This might just be the beginning of a rally after an extended period of consolidation.
The Business Transformation Plan
A key growth strategy and the vision of the company is the gradual transformation to a non-combustible future. Altria is planning the development of a portfolio of FDA authorized non-combustible products.
For example, the company’s oral tobacco product (on!) is now sold in 78,000 retail stores across the U.S. and has already captured a 2.4% market share in the oral tobacco segment.
Similarly, in the heated tobacco segment, the FDA has authorized the sale of the IQOS 3 tobacco heating devices in the U.S. This year, the company plans to expand the distribution of IQOS and HeatSticks into new markets and geographies. HeatSticks are already available in 1,000 retail stores.
The bottom line is that as the portfolio of non-combustible products expands, Altria is well positioned for a smooth business transformation over the next decade.
Cash Flows Remain Unaffected
A big reason to be bullish on Altria is the fact that the company continues to deliver healthy numbers. To put things into perspective, Marlboro’s Q4 2020 retail share was 43.3% and the leading cigarette brand continues to be a cash flow machine for Altria.
For the first nine months of 2020, Altria reported operating cash flow (OCF) of $5.8 billion. This would imply an annualized OCF of $7.7 billion. As a ballpark estimate, even if Altria reports OCF of $7.7 billion for the current year, free cash flow is likely to be $7.4 billion. Therefore, the company is positioned to pay dividends and pursue share repurchases.
On the flip side, the company’s investments in Cronos Group (CRON) and Juul have failed to create value and Altria currently has a debt burden of $29.5 billion. These are key reasons why MO stock valuations have remained depressed. However, a leverage ratio of 2.6 is not a concern as debt servicing remains smooth with healthy annual EBITDA.
Furthermore, if cannabis is legalized throughout the U.S. in the coming years, the investment in Cronos has the potential to deliver value. It’s worth noting that CRON stock has gained 110% in value over the last six months.
Word On The Street
Looking to Wall Street analysts, MO has a Moderate Buy consensus rating based on 4 Buy and 3 Hold recommendations. The average analyst price target of $50.33 implies upside potential of around 14% from current levels over the next 12 months. (See Altria stock analysis on TipRanks)
Concluding Take On MO Stock
Altria’s stock price seems to have discounted the bearish implications of its failed investments. Although the company has significant debt, robust free cash flows will allow the company to de-leverage while maintaining dividends at the same time.
The stock has been gradually trending higher in FY2021 and at current valuations, it’s very likely that the upside momentum will persist.
Altria stock underperformed through FY2020, but this year the stock has the potential to outperform the markets.
Disclosure: On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.