Thursday, March 22, 2018

RECENT BUY: UP IN SMOKE

Talk about a spending spree, well, relatively speaking.  I hadn't made any open market purchases, other than my 401k, since July 2015 and now in the span of a month I've made 2.  The pause wasn't for lack of trying or opportunities, rather it was due to the fact that since 2014 our lives have been one huge whirlwind.  

One of the great things about dividend growth investing is that, well, the companies pay you cold, hard cash.  For the most part I take all of my dividends in cash so this purchase wasn't made with fresh capital from savings rather from dividends, and some option trading profits, that have built up over time.  No matter where the cash comes from it still feels good to finally starting building up our dividend stream once again.


On March 1st I purchased 18 shares of Altria (MO) for $62.50 per share.  The total cost basis including commissions came to $1,129.95 or $62.78 per share. 

Altria is a Dividend Champion with 48 consecutive years of dividend increases.  Altria's quarterly dividend at the time of my purchase, more on that later, was $0.66 per share.  That puts the YOC for my position at 4.21% and I can expect to receive $47.52 in dividends over the next year barring any reinvestment or dividend increases.


Due to this purchase my FI Portfolio's forward 12-month dividends are $6,099.71.

How Does Altria Make Money?


Altria's business model is quite simple.  They make and sell cigarettes, smokeless tobacco and wine solely in the United States.  They have a very captive audience since the products are addicting which means one of the best things a business can here which is repeat customers.

Financials


Altria's business model leads to repeat purchases and with a very captive customer base that means they can raise the prices every year without truly damaging their earning potential.  Let's face it most people that smoke aren't going to quit because you raised the prices some.  That leads to consistent growth more often than not.


It helps that the tobacco business is relatively light in terms of capital needs.  Altria's brands also allows them to charge premium prices just for the name Marlboro on the box.  That leads to relatively high net profit and free cash flow margins. 



Those high profit margins mean plenty of free cash flow generation.  In addition to the dividend payment that grows every year, Altria also consistently repurchases shares.  From the end of FY 2008 to the end of FY 2017, Altria has repurchased 7.8% of the shares outstanding which is good for a 0.90% annual reduction of the share count.



Dividends


Altria's dividend history is something to marvel at.  Not only has the dividend yield typically been north of 4%, but it's also regularly grown in the high single digits, year after year, for nearly 50 years.  The apparent declines in 2007 and 2008 were due to the spin-off of both Kraft (KFT), which later became Kraft-Heinz (KHC), and Phillips Morris (PM), the international version of Altria.

  

A full screen version of this chart can be found here.

The 1-, 3-, 5- and 10- year rolling dividend growth rates can be found in the chart below.  


A full screen version of this chart can be found here.


After the dividend "cuts" from the 2 spinoffs Altria has continued on its dividend growth ways resuming its high single digit dividend growth between 7-9%.
 
Valuation



The valuation of Altria in the low $60's looks pretty compelling.

Based on the analyst estimates for 2018 earnings should come in around $3.98.  If those earnings come to fruition my purchase price would have been made at a solid 15.8x P/E ratio.  For a company that I deem to be high quality, that's a solid valuation especially compared to the rest of the market in general.

The following chart shows the future expected share price for Altria using earnings estimates of $3.98 for 2018, $4.36 for 2019, 8% per year growth for the next 3 years and 5% annual growth for the following 5 years.  I've used P/E ratios of 15x, 17.5x and 20x.



Another very rough valuation technique is to use the Dividend Discount Model.  Instead of solving for the price with an assumed growth rate, for a quick and dirty valuation I like to solve it backwards by figuring out what kind of growth rate is required to justify my cost basis at the time of purchase.


Using $0.66, $2.64 annual, as the starting dividend, my cost basis of $62.78 and a 10% required annual return, Altria needs to average at least 5.56% annual dividend growth in order to support my purchase.  Considering that Altria is consistently in the 7-9% range that seems like a fairly hefty margin of safety.  


Another way to look at it is to solve for the price based on the expected growth rate.  Using the $2.64 annual dividend, a 10% required rate of return and just a 6% growth rate gives a fair value price of $94.16.  

Starting Off With A Dividend Increase

What was really awesome about this purchase was that just a few short hours after it was made, Altria announced an unexpected increase to their quarterly payout.  Talk about instant gratification.

The dividend was raised from $0.66 to $0.70 or 6.06%.  Year over year the increase is a whopping 14.75%.  Since I now own 18 shares of Altria this raise increased my forward dividends by $2.88 on top of the $47.52 that the purchase boosted them by.  Shares currently yield 4.37% based on the new quarterly payout.  The dividend increase pushes my forward 12-month dividends up to $6,102.59.

Conclusion


It feels pretty good to slowly start making some purchases for my portfolio and to build up our dividend stream.  I think any additional purchases will probably be slow to come by while I wait for my dividends to pile up again although I do have a bit of cash ready for another small purchase if a good opportunity comes up.

Do you own shares of Altria?  At what price/valuation would you consider initiating a position or adding more to your portfolio?

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