Whither Altria?

Having divested its non-tobacco and international segments, Altria now operates primarily in the challenging U.S. tobacco industry.

Although Altria is the market leader, it has to face up to the fact that cigarette volumes in the U.S. are in structural decline. The powerful Food and Drug Administration (FDA), having assumed regulatory control, has been quick to assert its authority. And the threat of litigation is still omnipresent, despite a lull in high profile court cases.

Never mind these headwinds, tobacco manufacturing is still a lucrative business, so lucrative that Altria’s directors in January 2010 decided that they will pay about 80 percent of future profits as dividends, up from 75 percent.

If Altria is dishing out most of its profits as dividends, could this be taken as an indication that it is not planning any large-scale takeovers?

We think that this is the case.

Market observers have long wondered what Altria is going to do with its wine business, Ste. Michelle. Ste. Michelle’s sales of USD 403 million and operating profit of USD 43 million in 2009 were just a fraction of Altria’s overall revenue of USD 23.5 billion and profit of USD 3.2 billion.

While we do not expect Altria to take Ste. Michelle as the nucleus of an as-yet-to-be formed large-scale wine division, we do not think that Altria is in a hurry to sell Ste. Michelle off either. Multiples in the wine industry have reached rock bottom levels and Altria would be hard pressed to find a buyer willing to fork out 20 times Ste. Michelle’s operating profits as was custom only six years ago rather than perhaps a multiple of 8 or 10 times operating profits which appears to be the going rate these days.

However, what Altria is planning to do with its stake in SABMiller is really anybody’s guess.

But take a second to think: what would be left of Altria once all its paraphenalic investments are gone? The simple answer is: a U.S. tobacco company that no other tobacco company in its right mind would touch with a barge pole.

Let’s face it: who wants to have the FDA breathing down their neck all the time?

We think Altria is best advised to play mum and generate predictable cash flows, which can be purchased at a fair price. Even if Altria fails to continue its previous levels of growth, and gets bogged down by continued legal issues, the one-two punch of high dividends and a low stock price could still turn a seemingly high-risk company into a fairly safe investment.

Provided you don’t mind investing in “sin stocks”.