Altria Group, parent company of Philip Morris USA and its best selling Marlboro cigarettes, has more than lived up to its reputation as a defensive investment—providing investors with stable returns and, importantly, a dividend yield of 5.5%. That stands out in an environment in which money-market rates are less than 0.5% and 10-year Treasury bonds are yielding less than 2%.
No wonder then that the Richmond, Va.-based company has seen its shares surge 46% over the past few years, far outperforming the Standard & Poor's 500-stock index, which is up only 13% in the same time period. Last year, Altria shares (MO) gained 20% while the broader market finished the year at the same level it started.
But the shares look pricey, given some of the risks associated with Altria and its rivals in the tobacco business. Recently hitting a 52-week high of $30.40, also an all-time high after adjusting for the spinoffs of Kraft Foods and Philip Morris International, Altria is selling at mid-teen multiples while generating earnings growth in the high single digits.
Based on multiples of enterprise value to Ebitda (earnings before interest, taxes, depreciation and amortization), Altria, as well as others in the group, are trading a full point higher than their five-year averages.
While the stocks have soared, the long steady decline in U.S. cigarette sales has accelerated in the past year, with volumes falling nearly 4% amid a weak economy and continuing public backlash against smoking.
"Operating conditions in the U.S. cigarette industry are more difficult than generally recognized," says David Adelman, long-time tobacco analyst at Morgan Stanley.
To some extent, the industry has countered declining volumes with price increases, but pricing power has moderated as smokers' demographics have changed, making the industry more reliant on those who can least afford the habit in times of economic stress.
The number of young smokers continues to drop. Regulatory uncertainty has increased since the Food and Drug Administration added tobacco to its bailiwick in 2009. Litigation continues to be a challenge.
Altria, the biggest U.S. cigarette maker in terms of revenue ($16 billion) and market value ($60 billion) appears to be somewhat more exposed to industry woes, as its Marlboro brand has been losing market share.
It also is somewhat hamstrung by a heavy debt load after its 2009 acquisition of smokeless tobacco maker UST for $11.7 billion. Shareholder friendly actions that Altria is known for, such as boosting its dividend and buying back stock, could become less possible should pricing power fade.
Investors would do well to take profits in the stock now, before they are snuffed out.
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