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The global market selloff in 2022 has lowered stock prices and valuations but simultaneously increased yields. As a result, there are now bargains in dividend growth or income stocks. One stock that is trading at a reasonable price-to-earnings (P/E) ratio and a relatively high dividend yield is Altria ( NYSE:MO ). The stock is trading at a fair valuation of about 11.14X earnings with an excellent dividend yield of 6.66%. Interestingly, the stock price is up for the year, but still, few stocks offer this combination. If you are trying to live off dividends, the high dividend yield is attractive. Hence, Altria should be on your watch list.

Altria traces its history back to 1847 in London, UK. In 1902, Philip Morris was incorporated in the US. Altria was divested from Philip Morris and rebranded in 2003. In 2007, Altria spun off its 84% stake in Kraft Foods. In 2008, Philip Morris International was divested, and Altria kept Philip Morris USA. Today, Altria owns Philip Morris USA, John Middleton Inc, and US Smokeless Tobacco Company. Additionally, the company has sizeable investment stakes in Cronos Group (CRON) and JUUL, and 10% of AB-InBev (BUD).

Major owned and licensed brands are Marlboro, Parliament, Virginia Slims, Merit, Benson & Hedges, Black & Mild, Copenhagen, Skoal, Red Seal, Husky, iQOS, etc. Philip Morris International sells Marlboro and Parliament outside of the US. Altria is the market leader in cigarettes and smokeless tobacco and No. 2 in machine-made cigars. The Marlboro brand is the No. 1 cigarette brand in the US.

The current CEO is Billy Gifford. Total revenue was $21,111 million in 2021 and $21,050 million in past 12 months.

Altria is faced with several challenges. First, the cigarette market is in secular decline, with many consumers quitting. Hence, volumes are decreasing annually. Similarly, oral tobacco volumes are declining, albeit at a slower rate. Cigarettes face further regulation for nicotine and menthol. The FDA is looking at lowering nicotine levels in cigarettes. In addition, the US has proposed a ban on menthol in cigarettes. These changes will probably accelerate volume declines.

Because of the changing landscape, cigarette companies are increasingly focusing on smokeless tobacco and cannabis. Altria has investments in JUUL for vaping and Cronos for cannabis. However, the FDA has banned many vaping flavors, and Altria needed to write down part of its investment in JUUL. The cannabis market is competitive and regulated, too, likely limiting potential.

However, Altria holds the US license for iQOS, making the company a player in the heated tobacco market. iQOS is authorized by the FDA. Altria has the right to commercialize three versions of the Marlboro Heatsticks. However, iQOS was removed from the market in the US after a ruling from the US International Trade Commission (ITC) in a patent dispute placing Altria's ability to participate in this market in doubt for now.

Altria is an income and dividend growth stock. The company has raised the dividend for 13 years since the divestment of Philip Morris International, making the stock a Dividend Contender. However, some lists include Altria as a Dividend King, despite reducing the dividend in 2008 because the total dividend remained the same.

The forward dividend yield is now about 6.66%, based on an annual dividend rate of $3.60 per share. This dividend yield makes the stock a high-yield income stock.

Additionally, Altria increased the dividend by 4.7% in 2021. The trailing dividend growth rate is 8.42% CAGR in the past 5 years and 8.34% in the past 10 years. The growth rate is slowing because the payout ratio is now relatively high, and earnings per share growth have slowed.

Altria's dividend safety has declined, but the dividend still has reasonable safety metrics from the perspective of earnings, free cash flow (FCF), and the balance sheet.

Consensus estimates in 2022 for Altria are $4.86 per share, and the dividend is $3.60 per share. These values give a payout ratio of roughly 74%. Our cutoff payout ratio is 75%, meaning MO's value is just within our desired range. Altria's payout ratio has trended up with time but has been between 75% and 80% for the past several years. However, Altria has increased earnings and the dividend each year at nearly the same rate.

Altria had approximately $8,252 million in FCF in the past 12 months. The dividend required around $6,490 million, giving a dividend-to-FCF ratio of ~79%. This value is above our threshold of 70%, meaning there is some risk. However, Altria generates reasonably consistent cash flow each year, mitigating some risks.

Altria used to have a solid financial position. However, the company made several investments in the past few years, including Cronos and JUUL increasing debt. The JUUL investment, in particular, was problematic and required a writedown. At the end of Q1 2022, Altria had $2,517 million in current long-term debt and $25,405 million in long-term debt. Both total and net debt are now declining. Debt was offset by $5,353 million in cash and cash equivalents.

Debt is manageable. The leverage ratio is roughly 1.9X, and interest coverage has risen to ~10.3X. Altria has a BBB/A3 lower/upper-medium investment-grade credit rating from S&P Global and Moody's. Debt is concerning from the perspective of dividend safety, but the dividend is not at risk.

In a challenging year, Altria's stock price is performing well, with a positive return of about 13.74% year-to-date (YTD) as of this writing, well ahead of the S&P 500 Index and Nasdaq. Altria is trading at a forward P/E ratio of about 11.14X at the lower end of its average range in the past 5 years and 10 years.

The consensus analyst 2022 earnings are now $4.86 per share. We will use 12X as a reasonable value for earnings multiple. It is near the midpoint of the range in the past 5 years. We account for declining volumes, poor capital allocation, and high debt.

Our fair value estimate is $58.32. The current stock price is ~$54.08, suggesting that the stock is undervalued based on earnings.

Applying a sensitivity analysis using price-to-earnings (P/E) ratios between 11X and 13X, we obtain a fair value range from $53.46 to $63.18. Thus, the current stock price is ~76% to ~89% of the fair value estimate.

% of Estimated Value at Current Stock Price

How does this compare to other valuation models? An EV / EBITDA multiple analysis from finbox gives a fair value estimate of $65.44 per share. The model assumes a multiple of 10.1X. Portfolio Insight's blended fair value model accounting for the P/E ratio and dividend yield gives a fair value of $60.61 per share.

The average of these three models is ~$61.46, suggesting Altria is undervalued at the current price.

Altria is still a play on cigarettes and oral tobacco despite a secular decline due to health concerns, FDA approval process, advertising regulation, and taxes. Altria is trying to grow its smokeless tobacco business but with limited success. However, the company has been able to raise cigarette prices more than offsetting volume declines. Furthermore, the barriers to entry are incredibly high, limiting competition. Hence, investor returns have been relatively good. Investors seeking high yield and dividend growth may find Altria interesting.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.