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Altria Stock: Bull Case vs. Bear Case

In light of improving tobacco sector sentiment, 'TheStreet' has gathered bull-case and bear-case scenarios for Altria stock.
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(Altria story updated with additional comments from equity and credit ratings analysts on Altria stock)
NEW YORK (TheStreet) -- May tobacco data tells a tale of two tobaccos: on one hand, cigarette declines are at near historical levels; on the other hand, smokeless volumes remain healthy. Goldman Sachs analysts, in turn, have recently written of "improved investor sentiment on the tobacco space more broadly," in a recent investor note.

Consistent with the trend mentioned by Goldman Sachs,

Reynolds American

(RAI)

announced on May 28 that it would be eliminating 60 manufacturing jobs, as it expands its smokeless tobacco business and finds ways to cope with falling U.S. tobacco sales.

Meanwhile,

Altria

(MO) - Get Report

announced on May 20 that it was raising its moist snuff tobacco prices by 10 cents a tin, prompting similar moves by Reynolds and

Swedish Match

.

Separately, Altria announced on Jun. 1, in an SEC filing, that it has settled an income tax disagreement with the Internal Revenue Service (IRS) and will now be paying the agency $971 million in taxes and interest over returns for the years 2000 to 2003. Most of the settlement relates to leverage lease transactions involving subsidiary Philip Morris.

Altria's tax returns over the 2004 to 2006 period are still subject to investigation by the IRS, and Altria will probably have to make more payments, amounting to around $1 billion again, according to an investor note by Stifel Nicolaus analysts.

What does all this mean for Altria? In light of improved tobacco sector sentiment and notable announcements that Altria has made of late,

TheStreet

reaches out to several analysts and gathers some bull case and bear case scenarios for the stock.

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Bull case presented by Morningstar's Philip Gorham:

Marlboro is a strong brand that has a loyal customer base, and the addictive nature of cigarettes keeps smokers coming back for more. Even in light of the perfect storm of 2009: rising taxes, smoking bans on public places, and the recession; price elasticity of demand remained constant. This means that manufacturers can still keep raising prices at a faster clip than volumes are falling. There are no signs on the horizon that will change in the near term, according to Gorham in an email.

Bear case presented by Morningstar's Philip Gorham:

The bear case revolves around "fat tail" risk that a heavy litigation penalty could mean that Altria had to cut its dividend -- which would be horrible for the stock -- and that the industry is in long-term, perhaps terminal decline, Gorham said in an email.

Goldman Sachs' stock rating:

Neutral, with a $22 target price. Goldman Sachs analysts wrote in a research note that Altria's 10 cent per can increase on smokeless tobacco products translates to a 2 cent upside to earnings per share, assuming minimal volume impact -- and all else being equal. Overall, they believe the price increase announcement is positive for Altria and the smokeless tobacco industry.

Goldman Sachs analysts noted that the price increase should bolster investor confidence that both the Copenhagen and Skoal brands are now on much better footing and should continue to see healthy volume performance.

That the price increase also applies to Altria's newly introduced wintergreen product, is indicative of the company's satisfaction with consumer acceptance over the last several months, according to the analysts.

Bull case presented by Morningstar's Philip Gorham:

Altria's management is very focused on delivering cash back to shareholders. For antitrust reasons, acquisitions are unlikely; so all Altria can do with the vast free cash flow it generates is to give it back to shareholders through dividends -- it's current yield is 7% -- and share repurchases, Gorham emailed.

Bear case presented by Morningstar's Philip Gorham:

As volumes decline, margins are likely to fall because the manufacturing process is heavy on fixed costs, Gorham wrote in an email.

Credit Suisse's stock rating:

Neutral, with a $21 target price. Credit Suisse analyst Thilo Wrede noted in an investor report that Altria's settlement of its income tax dispute with the IRS "does not represent a penalty, but a resolution of uncertainty over the timing of the tax payment for the leases."

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That said, Wrede noted that he believes it can no longer be assumed that Altria will redeem $775 million of debt due this month, but will, instead, refinance it to free up cash for the income tax payment.

Bull case presented by Morningstar's Philip Gorham:

Altria is the largest player in U.S. tobacco manufacturing, with just more than 50% market share. Its nearest competitors are Reynolds American (29%) and Lorillard/Carolina Group (12%). Marlboro is the dominant cigarette brand in the U.S. with a 42% share, and as marketing restrictions become tighter over time, Morningstar thinks that competitors will find it increasingly difficult to erode the share of the leading brand, according to Gorham, in a recent report.

Bear case presented by Morningstar's Philip Gorham:

Rising excise taxes may be bringing forward the day that Altria is no longer able to raise prices to offset volume declines, Gorham emailed.

Stifel Nicolaus' stock rating:

Buy rating, with a $22 target price. The analysts wrote in a note to investors that the income tax agreement that Altria announced on Jun. 1 are already well-known, and that "encouragingly, free cash flow generation is quite strong here and can sufficiently handle the payment."

The $971 million tax payment "reflects an accelerated tax payment for future tax liability -- not a fine or incremental payment around these leases," Stifel Nicolaus analyst Christopher Growe noted.

Bull case presented by Morningstar's Philip Gorham:

Through its acquisitions of U.S. Smokeless Tobacco Company and John Middleton, Altria has positioned itself as the leading player in the total tobacco space in the U.S. and has achieved a limited amount of revenue diversification, according to Gorham, in a research note.

Bear case presented by Morningstar's Philip Gorham:

Restrictions imposed by the FDA could hamper manufacturers' efforts to diversify through new product lines, Gorham indicated in an investor note.

Citi's stock rating:

Buy/medium risk rating, with a $23.80 target price from $22.50, previously. The increase was prompted by the analysts' improved confidence in the overall industry outlook, they said in an investor note.

Although Citi thinks that Altria stock value was hurt by the financing and acquisition of the UST deal, this will be offset by factors that include improving market trends.

Ratings Agency Outlook for Altria

Fitch Ratings

has a stable rating outlook for Altria. "While Altria is heavily reliant upon cigarette sales, the company's ratings are supported by its diversification of operations within the tobacco space and the company's large stake in

SABMiller

, one of the world's largest brewers," the analysts wrote in a research note. They also said that Altria has significant liquidity, including undrawn facilities totaling $3 billion, consisting of a $600 million, 364-day revolving facility, which expires in November 2010, and a $2.4 billion, three-year revolving facility which expires November 2012.

Fitch noted that Altria's ratings are lower than those of companies with similar credit profiles largely because of tobacco industry factors including continued and potentially accelerating cigarette volume declines, and ongoing, though reduced, litigation risks.

Moody's Investors Services

has also given Altria a stable rating outlook, reflecting its view that the company's "profitability and cash flow will remain strong and predictable." The analysts wrote in a report that litigation risks remain an issue for the company, but are unlikely to create pressures on Altria's credit rating at this moment in time.

-- Reported by Andrea Tse in New York

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