I kicked this series off with Apple: https://quietprosperity.com/2023/09/22/old-blog-follow-the-fundamentals-apple-inc/

So for business number two, I figured I would go in a different (although just as addicting) direction. Tobacco.

As a quick refresher, the question is straightforward:

Based on what I have deemed to be important in business ownership, how many good stocks would I have actually identified along the way?

This is not to say I would have invested in them or even so, held for a long period, but would I have even given myself a chance?

As a refresher, here is what I deem to be important:

• Profitable – Absolute (Positive Cash Flow), Efficiency (i.e. ROIC), Margins
• Healthy – Manageable Debt, Fundamental Volatility, Negative Accruals, Self-Funding
• Growing – Positive Top-Line & Operating over last few years (Recessions noted in analysis)
• Yield – Returning some cash profits to shareholders?
• Valuation – Reasonable in context of growth? Chance for expansion or limited contraction?

I don’t have too many industries I avoid outside of banks/commodities, so the universe is vast.

Altria Group Inc – $MO

Unlike Apple, Altria is a a stock I own. I started buying some in early 2020 and have bought a little here and there over the last 18 months. One of the unique aspects about Altria is that is has been facing forms of various headwinds for decades. The % of smokers in the U.S peaked in the 1950s, volumes have been in decline since the 1990s, and there have been decades of negative PR (Mostly deserved) against the product.

Because of that, most people expect Altria (And Tobacco at large) to be a pretty “bad” business. I know I did. Turns out this is another reason why you need to do your own due diligence and trust the numbers.

Here are the previous 20 years of financial data for Altria. Since this is about “fundamentals” I will be referring back to this picture quite a bit:

Unlike some other companies I may look at, Altria had a noteworthy event which skews some of the financials. Altria and Phillip Morris International split in 2007. You can see the dramatic decline in revenues from 06-08. Just something to keep in mind as far as growth rates are concerned.

Altria Fundamentals

The Profitability history is fairly pristine. The lowest 5-year average was 17.5% and that came during the $PM spin. It has climbed all the way back above 25% since then. Operating margins have been 20+% for two decades and FCF margins (Key for a mature company in my opinion) have grown from ~13% to 30+% in recent years. That is scary good.

The financial health of the company has been mostly strong for two decades. Some accrual issues popped up in 16’/17′ due to AB InBev consolidation in 16′ and tax changes in 17′. Yes they are explained, but still quite a large accrual period in those two years. Coincidence that it happened in a period where the stock was trading at it’s most expensive levels in two decades? The only other ? mark (And this goes for most mature companies) is debt loads. FCF/Debt is getting close to levels I tend to shy away from (Sub 20%). I know their cash-flows are very strong and Altria does a good job of spacing out debt, but hard to imagine a world where it doesn’t impact shareholder yield at some point.

In terms of growth, if you exclude the $PM spin period, there has been consistent positive growth (Albeit small). Top-line seems to stay around 2% and with some margin expansion, operating income comes in closer to 4-5%. Given the low-capital needs, if bought at a reasonable price, 4-5% growth is all you need for a decent return.

Altria has consistently paid out large dividends while chunking some large buybacks form time to time. $108 billion returned to shareholders over the last 20 years (Versus $129B in FCF generated; ~84% returned). As an owner, that is incredible. Related to the note above is that because debt load has increased for acquisitions (And some buybacks), I expect to see FCF Yield and Shareholder Yield diverge a bit. Yes Altria can probably roll a lot of its debt as it comes due, but I would expect to see some debt paydown over the next decade.

Last is valuation. And despite the fundamentals being strong for so long, Altria’s valuation never really got too heated until 14’ish-18’ish. Long-term average multiple was 11x cash profits. At today’s market-cap, it sits around 11x. It dipped sub 10x at points last year (2020) but hard to argue buying a name at it’s long-term multiple, with a 7+% yield, a chance for maybe 4-5% growth in FCF, and profitability/margins like they have.

Conclusion

There are still many questions for tobacco moving forward. Every year seems to bring some new questions (Mostly headaches), proposed regulations, etc. There are also plenty of questions regarding the ethics of investing in Tobacco. It makes it a very challenging space to invest in.

Personally, I tend to believe in human choice. I am also on team drug legalization for most drugs anyways (Tobacco included). Assuming people are educated about the risks and regulations are in place to minimize second-hand smoke effects, it’s not for me to decide what someone else wants to do to their own body.

As for the investment itself? I highlighted 2001/2002, 2005-2013 and 2018-2021 as years where I would have considered investment from a fundamental perspective. It checks every box in those years. Using a 10% hurdle rate (5% growth) you can also see that selling in 2014-2017 would have come up as an option as well.

Again, who knows what questions I would have asked myself about Altria over the years. It’s very possible that the narrative of many headwinds would have made it to scary to buy, but by focusing on fundamentals, I would have at least given myself a chance at owning it. Not unexpected, but score another one for the “follow the fundamentals” theory.

Feedback and suggestions for future companies to look at are always welcome.

Have fun out there!