Some say that living off of dividends is the dream.
I’d say the real dream comes after you wake up to fresh money you didn’t go to sleep with the night before.
And you didn’t even do anything for the money… other than buy and hold shares in businesses that reward their shareholders with dividends.
It really can be that easy.
Look, life is tough and we’ve all got bills to pay.
But if one can offset bills with totally passive dividend income, that makes life a lot easier.
Imagine having a sizable amount of income coming in that you don’t work for, and this income covers most, or all, of your bills.
That’s a game changer.
Well, that’s what this series, where we do a deep dive on a high-yield dividend growth stock once per month, is all about.
We’re covering some of the very best high-yield ideas in the entire stock market.
By the way, these aren’t high-yield junk stocks where you have to worry about whether or not your dividends are sustainable.
These very real cash dividends are supported by very real business revenues and profits.
Plus, these are growing dividends.
That’s right.
In a reality where inflation is slowly causing the prices of everything to rise, eating away at one’s purchasing power in the process, we have to make sure that our income can also rise over time and keep up with increasing costs.
After all, a high yield becomes decreasingly effective over time if it’s slowly getting chipped away at by inflation.
With all of that in mind, I want to cover a high-yield dividend growth stock that can help you to cover your bills and make your life a lot easier…
Altria Group Inc. (MO)
Altria Group Inc. (MO) is an American producer and marketer of tobacco products.
Founded in 1822, Altria now has a $75 billion market cap.
The company operates across the following subsidiaries: Philip Morris USA, U.S. Smokeless Tobacco, John Middleton Co, Nu Mark, and Nat Sherman.
Altria also owns key equity investments that include a ~10% interest in Anheuser-Busch InBev (BUD), as well as a 45% interest in Cronos Group Inc. (CRON).
In addition, Altria most recently closed on its $2.8 billion acquisition of NJOY Holdings, Inc., an e-vapor maker.
Sales for Altria can be broken down across the following products categories: Smokeable Products, 90% of FY 2022 revenue; Oral Tobacco Products, 10%; and Wine and All Other, less than 1%.
After spinning off international assets in 2008, Altria sells tobacco products in the US exclusively.
As we can see above, in defiance of numerous attempts over several years to diversify the business, Altria remains heavily reliant on traditional tobacco product sales in the US.
I have some good news and some bad news for you.
The good news is that Altria absolutely dominates its market.
Through its flagship Marlboro brand, which commands and estimated 40% share of the market, Altria controls just over 50% of the US cigarette market.
That market share is incredible, and there are very few companies out there that can manage control of 50% of their market.
This speaks to the brand power of Marlboro.
Altria is the largest domestic player, although it has no international cigarette sales.
The bad news is that the US cigarette market is in secular decline.
The odds are very high that there will be far less smokers 20 years from now than there are today.
A shrinking customer pool is not healthy for long-term growth.
However, if you have to be in a market that’s experiencing secular decline, this is probably the best one there is.
A combination of entrenched brands, limited competition, inelastic pricing properties, and an addictive nature of high-margin products end up creating a cash cow.
Keep in mind, Altria’s current competition in traditional tobacco is likely all there ever will be, as high regulatory hurdles, limits on advertising, and secular decline all combine to put up high barriers to entry and practically prohibit new competitors from entering the market.
Altria would easily be one of the best businesses in the entire world if its market were in secular growth mode.
The fact that it can still put up modest growth in the face of secular decline just goes to show how powerful its characteristics are.
Morningstar puts it like this: “Although it is in secular contraction, the U.S. cigarette market is a relatively attractive one. We forecast the volume decline rate of the U.S. cigarette to be around 5% per year, a slightly faster rate of decline than most markets. However, the ability to consistently price above the rate of volume declines should ensure that Altria can continue to increase its revenue, earnings, and dividend.”
This highlights the crux of the matter.
In the face of consistent volume declines, Altria has demonstrated an ability to slowly push higher prices out into the market in order to compensate for volume loss.
That’s greatly aided by the addictive nature of its products, which creates “sticky” customers and allows for inelastic pricing.
Will this last forever?
No.
Nothing ever does.
But Altria remains a cash cow that’s steady for milking by shareholders who count on its large, growing dividend to meet real-life needs.
Dividend Yield And Growth
Indeed, Altria’s stock yields a monstrous 9.2% right now.
Not only is that attractive relative to the broader stock market and almost anything else out there, but it’s also attractive relative to the stock’s own five-year average yield of 7.5%.
The current yield is 170 basis points higher than its own five-year average.
Plus, this isn’t a static dividend.
Altria has increased its dividend for 54 consecutive years.
Just think about that.
Altria hasn’t just been paying a dividend but paying a growing dividend for more than five straight decades.
That’s the kind of reliability that investors crave.
With the yield where it’s at, you could get no dividend growth at all here and still be looking at a very decent return on investment.
For that to happen, Altria would simply have to avoid collapse.
However, since the dividend is growing, it’s a moot point.
Now, the 10-year dividend growth rate is 8.1%, although recent dividend raises have been in the mid-single-digit range.
In fact, Altria just raised its dividend by 4.3% in late August.
This kind of mid-single-digit dividend growth rate is basically what I’d expect out of Altria for the foreseeable future.
That’s not bad at all.
Like I just mentioned, when you’re starting out with a 9%+ yield, one doesn’t need a lot of growth in order for this to be a compelling dividend picture.
There aren’t many areas of the market where you’re going to get a yield of over 9%, let alone growth with it.
The payout ratio is 79%, based on midpoint guidance for FY 2023 adjusted EPS, showing that the dividend is definitely covered.
It’s an elevated payout ratio, yes, but it’s not worrisome, as Altria has operated with an elevated payout ratio for many years now.
We have a very high yield and modest growth – backed by a business which is committed to its dividend and shareholders.
For investors seeking yield, this might be about as good as it gets.
Revenue and Earnings Growth
Altria’s able to afford its large, growing dividend because the business is producing ever-higher revenue and profit by selling real products at ever-higher prices.
Indeed, Altria increased its revenue from $17.6 billion in FY 2013 to $20.7 billion in FY 2022.
That’s a compound annual growth rate of 1.8%.
Okay, so that’s not amazing top-line growth.
However, in light of the challenges that Altria’s core product are facing, including secular decline, I think it’s a very good showing.
Volume continues to decline, including a 9.7% decrease in volume for the Smokeable Products segment in FY 2022.
But Altria is, thus far, able to counteract volume declines with price increases.
And that’s helped both revenue and profit.
Earnings per share grew from $2.26 to $3.19 over this period, which is a CAGR of 3.9%.
We have excess bottom-line growth here, thanks largely to routine share buybacks.
Altria reduced its outstanding share count by approximately 10% over the last 10 years.
With the bottom line growing at a low-single-digit rate, we can see how and why dividend growth has moderated into a similar range.
And that’s what I’d expect to persist for the foreseeable future.
Consider Altria’s Q2 report for FY 2023 – its most recent – in which adjusted EPS increased by 4% YOY.
Also, Altria’s guidance for FY 2023 is also calling for 1% to 4% growth in adjusted EPS.
So that’s really what we’re looking at here.
It’s a mature business that’s growing its EPS and dividend at a low-single-digit rate, offsetting secular decline in volume with price increases, opportunistic buybacks, and strategic acquisitions at the margins.
That’s actually quite a pretty nice setup for income-seeking investors who aren’t necessarily interested in lights-out growth.
After all, the stock already yields 9.2%, so how much growth does one really need?
Not much, I’d argue.
As long as the stock doesn’t completely collapse, which I believe is extremely unlikely, that dividend sets a floor under one’s return.
And that floor is one made of cash, which helps to get the bills paid and offer up a good night’s sleep.
Financial Position
Altria’s financial position is also good, which helps to cushion the business and dividend.
Shareholders’ equity is negative, but the $25.1 billion in long-term debt is not at all obscene for a company with a market cap of $75 billion.
Moreover, the interest coverage ratio of nearly 9 shows us that Altria has no issues whatsoever with covering its interest expenses and managing its debt load.
I will say, Altria’s balance sheet has taken a hit in recent years, as Altria took on quite a bit of debt in order to fund an ill-fated $13 billion acquisition of e-cigarette maker JUUL Labs – an acquisition that later had to be totally written off.
But Altria’s balance sheet is not in dire straits at all.
Profitability
Profitability, on the other hand, is excellent.
This isn’t a surprise, as its core product is cheap to make and can be sold at high prices.
There’s no measurable ROE, due to the aforementioned negative equity.
However, Altria’s ROIC has averaged 18.6% over the last five years, while net margin has also averaged 18.6%.
An anomalous FY 2019 throws the averages off, but Altria is consistently putting up very high returns on capital and margins.
Altria also has considerable durable competitive advantages, which include brand recognition, pricing power, limited competition, inelastic pricing, scale, addictive products, and huge barriers to entry.
Risks
But there are risks to consider.
Competition, regulation, and litigation are omnipresent risks in every industry.
Litigation has long been a huge concern in this industry, as evidenced by the Tobacco Master Settlement Agreement.
Regulation cuts both ways.
Regulation has effectively made it impossible for new entrants to come to market in the cigarette space, which creates rational pricing and additional pricing power among the firmly entrenched incumbents.
However, regulation has also definitely hurt Altria.
A prime example of this is the decision by the US FDA to withdraw authorization for JUUL products, which partially led Altria to write off its entire investment.
The JUUL disaster reveals execution risk, hurt Altria’s balance sheet, damaged the company’s reputation, and further concentrates the business into traditional tobacco products.
There’s also regulatory risk regarding menthol.
There’s a looming chance that the US FDA will ban the use of menthol in cigarettes at some point in the future, which would have a material impact on Altria (Altria generates an estimated 20% of its sales in the menthol category).
Recent deterioration of the balance sheet limits financial flexibility and M&A opportunities.
Any acceleration in volume declines of traditional cigarettes off of what’s an already-high level will make it very difficult for Altria to keep up and offset it with pricing increases and alternative product sales.
Alternative products – namely, e-cigarettes – are now a viable alternative to traditional cigarettes, which threatens Altria’s business model.
No investment is without risk, and Altria is no different.
But these risks and issues are why the stock offers a sky-high 9%+ yield.
I think they also go a long way toward explaining the extremely undemanding valuation.
Valuation
The stock is trading hands for a P/E ratio of 11.1.
That’s based on TTM GAAP EPS.
If we use midpoint guidance for FY 2023 adjusted EPS, the forward P/E ratio drops to just 8.5.
These are absurdly low earnings multiples in an environment in which the broader market’s earnings multiple is well over 20.
But it’s not just a market comparison that makes Altria look cheap.
It also looks cheap relative to itself.
The current sales multiple of 3.7 is quite a bit lower than its own five-year average of 4.2.
The P/CF ratio of 8.7 is also disconnected from its own five-year average of 10.8.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
In order to estimate the intrinsic value of the business, I used a dividend discount model analysis.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
I factored in a 10% discount rate and a long-term dividend growth rate of 2%.
Now, that dividend growth rate may look low, or even downright disappointing, to prospective or existing shareholders.
But I think it’s quite appropriate.
Altria is growing earnings at a low-single-digit rate, and guidance for this year is calling for 2.5% (at the midpoint) YOY adjusted EPS growth.
That’s close to what I’m proposing here.
We also have to keep the high payout ratio in mind, as well as the fact that volume trends are not encouraging.
All that said, it’s worth repeating that Altria doesn’t need to put up a lot of growth in order to make sense of an investment.
This is a high-yield stock, not some high-quality compounder growing at a blistering rate but only offering a minuscule yield.
So we have to right-size our expectations relative to what Altria is realistically doing.
For income-oriented investors looking for a sizable and reliable dividend, even just modest growth that can offset inflation could be enough.
The DDM analysis gives me a fair value of $49.98, which would indicate the stock is possibly 15% undervalued.
Bottom line: Altria Group Inc. (MO) is a great high-yield dividend growth stock to consider for income-oriented investors looking for a large, reliable dividend to help get the bills paid. It offers a sky-high yield of over 9%, more than 50 consecutive years of dividend increases, a manageable payout ratio, and a low-single-digit dividend growth rate. Plus, with an undemanding valuation, the stock looks potentially 15% undervalued. There really is a lot to like here, despite some risks.
-Jason Fieber
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.