tiero/iStock via Getty Images
tiero/iStock via Getty Images
Altria (NYSE:MO ) and Philip Morris (NYSE:PM ) are staples in millions of retiree portfolios and for good reason.
Altria is not just a legendary dividend king, with 53-year of consecutive dividend increases to its name, but it's also the best performing stock in history.
And what's more, both companies, thanks to their low volatility, and recession-resistant natures are helping income investors sleep well at night during this bear market.
The worst bond bear market in history means that so far this year, bonds have not been a hedge against falling stocks.
In a year of fear, uncertainty, and doubt, when over 50% of the S&P 500 is in a bear market and half of the Nasdaq is down 50+%, PM and MO are both up about 14%.
Many income investors own both companies, as do I.
Many income investors sleep well at night cashing these very safe dividends, as do I.
But recently something important changed about one of these companies' investment thesis that you should be aware of.
It pertains to which is the better long-term investment today.
In other words, this breaking news means that with the question of MO vs PM, the better investment might shock you.
Morningstar considers PM the best-managed tobacco company in the world, and most analysts, rating agencies, and I agree, for one big reason.
The company began investing in IQOS heat sticks in 2014 and since then it's spent $9.2 billion on transitioning to a smoke-free future.
PM's future goals are based on
In other words, within about 20 years PM might no longer sell cigarettes and be no more controversial than alcohol companies are today.
PM's 2021 results were spectacular with 7.6% revenue growth, 5.3% revenue per unit growth, 2% higher operating margins, and 15.3% earnings growth.
Thanks to IQOS PM HAD become the growth king of tobacco, posting 10.5% annual growth over the last five years.
The company is spending about $1 billion per year, virtually its entire R&D budget, laser-focused on the day when it doesn't sell a single cigarette to anyone, anywhere, ever again.
PM's more than $9 billion in IQOS spending has paid off, with IQOS now the 2nd most popular nicotine brand in the world, at least in the markets it's currently in.
Management's primary goal is a smoke-free future, with goals of getting more than half of revenue from RRPs by 2025.
BUT that was last year and today the world has changed, in a big way.
PM was badly hurt by the war in Ukraine, cutting 2022 EPS guidance to $5.40 from $6.21.
PM gets 6% of its sales from Russia and 10% of its volumes.
MO has zero exposure to the war directly because its sales are 100% domestic.
PM's RRP sales growth is still strong at 23% and it managed to still gain over 1 million IQOS users, excluding Russia and Ukraine.
Russia and Ukraine account for 23% of IQOS volumes, which means that this war is proving a potentially significant blow to PM's smoke-free future plans.
After announcing the $16 billion acquisition of Swedish Match, two of PM's three rating agencies are considering cuttings their credit rating.
The negative CreditWatch placement reflects our view that there is an increased likelihood that we could lower the rating on PMI by one notch. PMI proposed acquisition of Swedish Match assumes a total consideration of about $16 billion, to be paid fully in cash. Under our base case scenario--accounting for the proposed transaction--we expect PMI's S&P Global Ratings-adjusted debt to EBITDA (pro forma) in 2022 to be about 3.0x, up from 1.9x in 2021. For subsequent years, we then expect a gradual deleveraging trend, with adjusted leverage remaining in the 2.5x-3.0x range. The deleveraging trend is supported by recurring and healthy annual free operating cash flow (FOCF) reported in the range of $9.0 billion–$9.5 billion (after capital expenditure and working capital requirements), although most of this will be used for dividend payments, with an estimated annual cash-out of about $8.0 billion, growing progressively each year. Positively, the company announced the suspension of its share buyback program which began in July 2021." - S&P (emphasis added)
Moody's is reviewing PM for a downgrade to A- as well.
The review for downgrade will focus on the impact of the take-over on PMI's capital structure and financial policies and will assess the ultimate structure and funding mix of the acquisition financing and the potential increase in leverage. From preliminary analysis, based on the current proposal, any potential rating downgrade is likely to be limited to one notch. Moody's expects to complete the review upon completion of the transaction." - Moody's
For now, Fitch maintains its A stable credit rating.
Why is PM buying Swedish Match?
Swedish Match is a Stockholm-based market leader in nicotine pouches, moist snuff, U.S. chewing tobacco, and cigars, and it has a smaller business in lighters. In Scandinavia (defined as Norway, Sweden, and Denmark) the company commands half of the market for smokeless tobacco and nicotine products, a market dominated by snus. In the U.S., the firm is the leader in nicotine pouches with a 64% share, according to the company's own estimates, and it owns ZYN, the leading U.S. brand. However, On, a competitive brand owned by Altria, has taken some share in recent quarters. Swedish Match also owns the leading U.S. chewing tobacco brand America's Best Chew and commands a 40% share. The company is a distant third player in moist snuff, a category dominated by Altria, with a 9% share through its Longhorn brand.
Like Altria's smokeless segment, Swedish Match is a highly profitable business with a superior profile relative to cigarettes. It generated a nearly 45% operating margin in 2021 and has expanded profitability every year since 2016. Revenue has grown by double digits since 2018, driven by footprint expansion in the U.S., its smoke-free business, and strong pricing power. Our back-of-the-envelope estimate suggests the company generates roughly 100% return on invested capital, above even its larger peers in the tobacco industry." - Morningstar
It's a rapidly growing and highly profitable business and one that can help PM diversify its smoke-free future plans away from just IQOS.
PM's IQOS remains the #1 smoking cessation tool in history, with 71% of users trying it and permanently quitting smoking.
Thanks to lockdowns easing, easy comps, and the strength of IQOS, PM was able to deliver 2.2% volume growth last year, the first time since the spin-off that volumes have gone up.
The good news is that the world is a lot bigger than Russia and Ukraine, and PM has tapped just 4% of the global addressable market.
PM's wellness and cannabis market ambitions, represent an $89 billion annual growth market, one that's expected to grow 11% annually through 2030.
PM's 4.7% yield remains very safe, though the dividend is now expected to grow a lot slower than before the Russian invasion.
Before Russia invaded Ukraine PM was the growth king of tobacco with analysts expecting 12.7% long-term growth at one point.
Combined with a very safe 5% yield that meant potentially 16% to 17% long-term total returns.
But remember that 23% of IQOS sales are in Ukraine and Russia (about 15% Russia). So what does the growth outlook for both companies look like now?
Why are analysts so much more bullish on MO than PM?
Because MO's long-term future is also based on a smoke-free future.
In heated tobacco, our teams are continuing to work with PMI on IQOS re-entry plans, and we will keep you informed on developments as circumstances warrant. There is no change to our expectations regarding IQOS product availability." - MO CEO, Q1 conference call
Is this a risk-free investment? Absolutely not, there is no such thing as a risk free stock.
Some analysts believe that PM buying Swedish Match might prevent MO from marketing IQOS in the US.
However, that's not the consensus, for one simple reason.
This means the US remains a massive untapped market for IQOS and analysts believe that PM's agreement with MO has PM obtaining the majority of IQOS revenue.
Rather than go to war with MO and try to market IQOS around its back, which MO would likely sue over, most analysts believe PM and MO will still eventually launch IQOS in the US.
So what does this fundamentally mean for high-yield investors trying to decline between MO and PM today?
10 Year Inflation And Risk-Adjusted Expected Return
It means that Altria is expected to outperform the S&P 500 and aristocrats in the future, just as it has for over 90 years.
It also means that PM is now expected to potentially deliver just 7.8% long-term returns.
What kind of difference does an extra 3.3% per year in returns mean?
(Source: DK Research Terminal, FactSet)
Over many years and decades, it could amount to a small additional fortune for MO investors.
(Source: DK Research Terminal, FactSet)
In fact, it could potentially mean that MO outperforms PM by over 3X in the coming decades.
But you don't necessarily need to wait for decades to enjoy far stronger returns with MO than PM.
FAST Graphs, FactSet FAST Graphs, FactSet
If PM grows as analysts expect by 2024 it could deliver 22% total returns, or 8% annually.
FAST Graphs, FactSet FAST Graphs, FactSet
By 2027 if PM grows as expected (2.8% CAGR) and returns to historical fair value, it could deliver 43% total returns or 6.5% annually.
PM is 4% historically overvalued now, trading at almost 19X earnings after the guidance cut.
MO, in contrast, is 21% historically undervalued and is now expected to grow almost twice as fast as PM over time.
FAST Graphs, FactSet FAST Graphs, FactSet
If MO grows as analysts expect by 2024 it could deliver 63% total returns, or 20% annually.
FAST Graphs, FactSet FAST Graphs, FactSet
By 2027 if MO grows as expected (4.7% CAGR) and returns to historical fair value, it could deliver 103% total returns or 13% annually.
There is a lot more to deciding on what company to entrust with your hard-earned money than just valuation and growth potential.
(Source: DK Research Terminal, FactSet)
PM has a lot going for it.
BUT MO simply has PM beat in so many ways that matter.
With PM's new lower guidance making shares modestly overvalued, I think the case is clear for buying Altria over Philip Morris today.
I have no plans to sell my PM shares, just because its return potential is now under my 8% minimum for defensive blue-chips.
Years For The Thesis To Break Entirely
However for new money today I think the case is strong (as Goldman has pointed out) that Altria is the superior long-term high-yield dividend growth investment.
In this bear market, there are blue-chip bargains raining from the sky. And even Warren Buffett has limited dry powder to put to work.
If you're looking for a safe haven in today's market terror, consider Altria, and its nearly 7% very safe yield and low volatility, recession-resistant business model.
As part of a diversified and prudently risk-managed portfolio, the best performing stock in history has what it takes to let you sleep well at night and retire in safety and splendor.
Dividend Kings helps you determine the best safe dividend stocks to buy via our Automated Investment Decision Tool, Research Terminal, correction planning tool, Company Screener, and Daily Blue-Chip Deal Videos.
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This article was written by
Adam Galas is a co-founder of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 5,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha).
I'm a proud Army veteran and have seven years of experience as an analyst/investment writer for Dividend Kings, iREIT, The Intelligent Dividend Investor, The Motley Fool, Simply Safe Dividends, Seeking Alpha, and the Adam Mesh Trading Group. I'm proud to be one of the founders of The Dividend Kings, joining forces with Brad Thomas, Chuck Carnevale, and other leading income writers to offer the best premium service on Seeking Alpha's Market Place.
My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives.
With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and safe and dependable income streams in all economic and market conditions.
Disclosure: I/we have a beneficial long position in the shares of PM, MO either through stock ownership, options, or other derivatives. 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.
Additional disclosure: Dividend Kings owns both PM and MO in our portfolios.