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Altria (NYSE:MO) has made a lot of headlines over the past 12 months, giving investors plenty to ponder. Make no mistake, this is a company in transition, and while not everyone is happy with the risk profile, I believe it’s one where investors can be rewarded over the long term. In this article, I’ll highlight the recent development and why I believe this is positive for Altria over the long term.
Why MO?
Altria made headlines this week when it was recently announced that Philip Morris International (PM) is amicably terminating its IQOS partnership agreement, opting instead to do it either alone or through Swedish Match (OTCPK:SWMAF), should Elliot Management and the The rest of the shareholders agree to the recently increased offer.
The launch of iQOS was problematic from the start, as Altria introduced it to the U.S. market just before the pandemic hit. Competitor British American Tobacco (BTI) then successfully sued PM for patent infringement, resulting in an import ban. This meant PM had to set up its own iQOS manufacturing facility on the US coast to sell the product. To add salt to the wound, PM and Altria were also at odds over whether Altria has met its contractual obligations in marketing IQOS.
While IQOS is indeed a product that has resonated with consumers around the world, the agreement between the two companies came with an element of uncertainty. This is because the partnership was not an eternal one, with periodic milestones that had to be achieved in 5 years. Should Altria fail to meet PM’s expectations, PM could pull the plug and all efforts would have been for naught. More importantly, Altria would have lost valuable time developing and commercializing its own heat-not-burn product.
As with people, it’s important for companies to take charge of their own destiny, and PM’s iQOS settlement gives Altria plenty of capital to build its own product. This was highlighted by Morningstar in its recent analyst report:
The news that Altria and PMI are parting ways regarding iQOS comes as no surprise given PMI’s bid to acquire Swedish Match, and the confirmation of the terms of the split provides insight into the cash flow impact of the split for the next two companies Years. Altria has already received $1 billion and will receive the remaining $1.7 billion by early the second half of next year. Management has not been sure how it will use the proceeds, but we believe the proceeds will be sufficient to develop its own heated tobacco brand and grow returns for shareholders for years to come.
Using PMI’s spending as a benchmark, we estimate that a dedicated heated tobacco factory to supply the US market could cost around $400 million and double R&D expenses as a percentage of sales to 1.8%, similar to that PMI Spending on Ramp Up iQOS distribution in Europe and Asia and increasing ad spend to 1% of sales from a negligible amount has no impact on our valuation of Altria, leaving approximately $1 billion in after-tax earnings for distributions the shareholders left.
While time will tell how successful Altria’s HnB product will be, I believe the lessons learned from PM’s IQOS playbook serve as a valuable guide when developing a new product. Additionally, I view Altria’s recent decision to end its non-competition clause with JUUL as positive.
That’s because Altria only had a 30% stake in JUUL, and there was no telling when, if ever, JUUL would return cash to its investors. Given the amount of regulatory oversight and FDA scrutiny of vaping, this segment is beginning to mature and fits well with Altria’s experience of working within a regulatory framework.
Meanwhile, near-term uncertainty is high for value investors as Altria is attractively priced at $44.48 with a blended PE of 9.3, below its normal PE of 15.7 over the past 10 years . Additionally, it has a BBB-rated balance sheet and pays a historically high yield of 8.5%, well backed by a 77% payout ratio. Notably, MO is also a Dividend King with 52 consecutive years of dividend increases.
MO rating (FAST graphs)
Investor Takeaway
While the end of iQOS’ partnership with Philip Morris International can be viewed as a negative, I believe it’s a long-term positive for Altria as it gives the company more control over its destiny. In addition, it also offers Altria the opportunity to use the proceeds to develop its own heated tobacco product while increasing shareholder value. Meanwhile, negative investor sentiment has pushed the dividend yield to the high end of MO’s historical range, setting it up for potentially rewarding long-term returns.