Tuesday, September 27, 2011

Altria: Time To Consider Selling This Stock

It's interesting to see the stocks that are being recommended most frequently by the average retail investors. With interest rates at historic lows, few investments have gotten more attention lately than income and dividend based stocks. I would say Altria (MO) is one of, if not the most, mentioned of these stocks.

Having owned a number of high paying dividend stocks myself, I certainly appreciate the value of having these kinds of investments in a portfolio. However, just as not all companies are created equally, it is a hard fact that not all dividends can be maintained and grown either. While I have owned MO in the past, I now think people should seriously reevaluate their position in this company, and strongly consider selling this stock.

In an article I wrote several months ago, "LO: The only U.S. Tobacco Stock Worth Investing In", I discussed why LO (Lorillard) is in a far better position than both of the company's major competitors; Altria and Reynolds (RAI). Given the recent business decisions Altria has made, I now think that people should strongly look to avoid this stock.

Altria has had a good ride for sure. As the top performing stock in the S&P 500 for many years, investors have reaped significant profits from this company's strong growth and shareholder friendly policies. Altria has grown significantly over the years, and shareholders have benefited as much as anyone from the company's dedication to return value to shareholders. However, today Altria looks like a much different company. At first look, Altria's share price and dividend yield seem to suggest that the company is doing fine. The stock trades at around 12-12.5x a reasonable estimate of next year's earnings, has a dividend yield of over 6%, and has performed well even during the recent period of market turmoil. Unfortunately, if you look underneath this information, the picture begins to change.

The first red flag that jumps out when you look at MO as an investment is the debt load carried by the company. Altria portrays its business model as a cash flow machine and has grown its dividend at a double digit rate for much of the last fifty years. This is why it is interesting that the company carries about 14 billion in long-term debt despite having free cash flow of about 4 billion a year that is used almost exclusively to pay the roughly 6% dividend. Given the company's strong cash flow, the debt load would not ordinarily look that bad. However, when you look at Altria's specific debt there are some concerns that seem worth inquiring about. Altria borrowed at around 8-10% to acquire UST, an acquisition which has returned decent, but not great, results.

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