Shares of Altria (MO) - Get Report seem the perfect safe haven in a market that many perceive as bearish. Its above average yield, strong international business, a potential spinoff of its consumer products division, and reduced litigation risk offer long-term appeal.
However, a closer look at the potential downsides of owning Altria at the current price suggest that neither its 4.5% dividend nor the pending spinoff of
is a good enough reason to own the stock.
Altria is the largest tobacco company in the world based on sales, and the company owns 85% of Kraft, which is the largest food and beverage company in North America. Management has been adamant about a Kraft spinoff for over 12 months, and it was originally forecast to transpire early this year.
But because of numerous lawsuits -- most notably one that seeks the largest amount of punitive damages against tobacco firms in U.S. history -- it is difficult for the company to gauge the timing of any spinoff, and I believe it may not take place until mid-2007.
The Engle lawsuit in Florida was a two-year trial from 1998 to 2000 that ended in a $145 billion punitive damages award against tobacco companies. The judgment, overturned by an intermediate appellate court in 2003, is now being reviewed by Florida's Supreme Court. A ruling on the case is expected in the next few months.
Management is acting prudently by waiting until the lawsuits are settled, but during this time Kraft has received numerous analyst downgrades based on lower volumes and higher costs. Because Kraft receives 14% of its sales from
, the largest discount retailer in the world, margins are more easily squeezed. Kraft management has been restructuring its business since 2004 and has fired CEO Roger Deromedi because of its lagging financial performance and flat sales. In fact, Kraft is now trading below its June 2001 initial public offering price of $31.
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Altria will benefit from the ultimate spinoff of Kraft, but I believe this news is already factored into shares, since it was announced over a year ago. With Kraft's business deteriorating quarter after quarter, it would be in Altria's best interest to spin off Kraft sooner rather than later, but sooner doesn't look likely.
Weakening Business Trends
Beyond the Kraft relationship, Altria derives 75% of its profit from tobacco -- 47% international and 28% domestic. New anti-smoking legislation in the U.S., including bans on smoking in indoor areas such as restaurants, bars and sporting events, could squeeze Altria's bottom line.
Other obstacles to the tobacco business are rising excise taxes in Texas and California, set to take place in 2007, which will lead to additional price hikes for cigarettes. This could result in a switch to cheaper alternatives for smokers. Also, anti-smoking advertising campaigns have started hurting the Philip Morris brand.
On the international front, the Europeans are following in the footsteps of the U.S., adopting new tobacco laws that restrict the sale of certain tobacco products and raise taxes on cigarettes. Ireland was the first country to forbid smoking in public places in 2004. Italy and Scotland have banned smoking in enclosed places and the U.K. is set to join them in 2007. This has led to a decline in the number of smokers; in the U.K, it's gone from 33% to 27% since 2002. This declining trend does not bode well for Altria.
Investors are attracted to Altria because of its above average 4.5% yield; the dividend is covered by more than 2 times 2007 projected earnings. But this is no reason to own the stock. Money market accounts are currently paying more than 4.5%, and investors don't have to assume the risk of a huge litigation payment.
So to recap, Altria's tobacco business is deteriorating in the U.S. and abroad. Kraft is also under pressure, and restructuring initiatives will not be felt until long after the company is spun off. And the dividend is less compelling now that there are other alternatives offering the same yield with relatively no risk.
Should you consider an investment in Altria shares? It's always dependent on your situation, but I'd say no.
In keeping with TSC's editorial policy, Frank Curzio doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Frank X. Curzio is a research associate at TheStreet.com, where he works closely with Jim Cramer. Previously, he was the editor of The FXC Newsletter and senior research analyst for Greentree Financial.
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