When someone considers buying a stock, there are two types of thoughts that could enter his mind: market decisions and investment decisions. A market decision is what you’d expect; someone buys a stock and expects the price to go up, usually within a few months, or a year or two maximum.
An investment decision is much more binding in a self-imposed way—you are saying, “I really like the business economics here, and I believe this company is going to be generating much higher profits five, ten, even fifteen to twenty years from now. Getting past the obvious niceties that nothing is ever certain, you reach the conclusion that a company worthy of such an investment has a high probability of achieving the returns you predict.
One of the companies that is difficult for me to study is Altria, the historic tobaccomaker that went by the name Philip Morris until it changed its name to the bland “Altria” about a decade or so ago for public relations reasons, err, to reflect “its comprehensive business” at the time.
If you’ve been reading the site for a while, the story of the old Philip Morris is old hat to you: from 1926 to 2003, the old Philip Morris was the absolute best stock you could have purchased and held at that time period, giving you 17% annual returns even though the core business only grew at 11% over that time frame. That humongous six percent spread is the product of Altria’s perpetual undervaluation that allows investors to reinvest and then receive higher income going forward than they otherwise would have a right to receive.
Part of me wonders how much worse the taxation and regulation facing tobacco can get from here: Entirely bland packaging? Only smoking in homes? Doubled taxation rates from here? I’m not sure there’s a lot left to wring out of the industry, and I wonder whether politicians will ever truly deliver a death blow to the business because the Big Three tobacco companies contribute heavily to the funding of state budgets, particularly education.
I’m thinking out loud here, but I wonder whether Altria and Reynolds American will be able to reinvent themselves in a Wells Fargo manner, using smokeless tobacco, e-cigarettes, wine and beer to carry themselves through the coming decades.
What particularly catches my attention about Altria is this: the company owns 27.0% of SABMiller, the legendary brewer. For someone who owns a share of Altria now and intends to hold for the long term, I wonder what is going to happen to that SABMiller stake over the long term. Will something like Anheuser-Busch eventually succeed in buying it out, thus giving Altria tens of billions of dollars in cash to either acquire new businesses or give shareholders a massive, one-time dividend?
Will it get spun off like Philip Morris International and Kraft, giving Altria shareholders an ownership stake in both tobacco and beer separately? It doesn’t get a whole lot of attention now because it quietly adds a couple hundred million dollars to Altria’s balance sheet each year in the form of SABMiller dividend payments, and the fact that it has a total valuation fluctuating between $20 and $30 billion makes it a colossal stake that doesn’t get fairly taken into consideration when Altria is contemplated as a potential investment.
When used as a modest part of estate planning, Altria could serve a useful purpose. Imagine owning 1,000 shares of Altria that constitutes a 3-6% of one’s portfolio. You’d get $1,920 in annual dividends (based on the typical 2014 rate of $0.48 per share) that you could mix with fresh cash from elsewhere to make brand new investments as part of a perpetual “de-risking” plan in the event that the political risk associated with tobacco proves worse than anticipated. Do this for a decade or so, and the growing dividends from Altria combined with the growth of your new investments would make Altria something akin to house money in that even if the company were to completely fall off the face of the earth, you’d still breakeven. It’s a great contingency plan.
More likely, Altria will continue to raise its dividends, you’d be able to make a mini blue-chip portfolio funded entirely from Altria dividends over the years, and at some point in time, that SABMiller stake will come to create significant wealth either due to a spinoff or in the form of a special dividend.
Using tobacco dividends to buy other cash-generating assets seems to be the best way to recognize Altria’s exceptional long-term returns and unique ability to offer a high current yield mixed with high current growth, while also hedging against the unique political risks in the tobacco industry. And meanwhile, that 27.0% stake in SABMiller just sits there quietly.