Altria (MO) is a holding in both the portfolio of the Best Ideas Newsletter and the portfolio of the Dividend Growth Newsletter. The company operates in one of the strongest industries in our coverage universe as it relates to structural composition (think Porter’s 5 forces). The oligopolistic tobacco industry is attractive in a number of ways. Firms in the industry sell an “addictive” product (cigarettes and/or smokeless tobacco), have significant pricing power, generate high margins, and have strong returns on invested capital. Though declining trends in smoking in the US, threats of tobacco-related litigation, new tobacco regulation (labeling) that discourages tobacco use, and excise tax price shocks that may impact demand will always be concerns, we tend to like the structural characteristics of the tobacco industry and the shareholder-friendly (dividend) policies of constituents.
Altria also has an attractive position in the alcoholic beverage industry, which itself acts as an oligopoly. The cigarette giant has a 27% economic voting interest in SABMiller, the value of which we attribute to Altria’s current mispricing relative to our intrinsic value estimate ($40 per share). Said differently, a large portion of our thesis on Altria’s undervaluation rests on the value of “hidden” assets – or those assets that aren’t readily apparent on the financial statements. Our latest estimates peg Altria’s stake in SABMiller at more than $20 billion, though we note currency volatility impacts the value of its stake on a daily basis (see here for more detail on Altria’s stake in SABMiller). We’ve reproduced our assessment of the structural characteristics of the alcoholic beverage industry below (source):
The beer industry is structured as an oligopoly, with four players generating over 70% of industry profits. Though smaller industry constituents may price competitively at times, we view the overall industry structure as a rational oligopoly. We expect further consolidation in the space and would not be surprised to see the larger players participate. Global operators will benefit from exposure to Asia and Africa, where beer consumption is growing at a pace several times that of mature markets such as North America and Western Europe. We like the structure of the group.
Members of Valuentum know that we don’t pass out praises about industry structure very lightly, and it’s very uncommon for a firm to participate in two industries with strong structural characteristics as Altria does.
Monday brought some interesting developments with respect to both the tobacco and alcoholic beverage industries – both news items related to further consolidation. Though we cannot substantiate such claims at this juncture, UK media sites are reporting that Reynolds American (RAI) is interested in buying rival tobacco-maker Lorillard (LO) – source. The media outlets suggest that a buyout in the range of $18-$22 billion for Lorillard may be on the horizon, the midpoint slightly higher than where shares are currently trading at the time of this writing. At present, our fair value estimate for Lorillard does not capture the potential of a takeout premium, though our fair value range leaves open the possibility of an interested suitor paying near the high end (closer to $60 per share). We reiterate, however, that we do not like speculating on takeover activity, but we do note that any further consolidation in tobacco would only be positive for portfolio holding Altria.
Bloomberg reported the same day that AB Inbev (BUD) may be considering tying the knot with fellow beer giant SABMiller – which is partially held by Altria. As economic profits are generally inversely proportional to the number of operators in a particular industry (fewer competitors, greater excess profits), we’re generally in favor of industry consolidation on any level. SABMiller CEO Clark has recently been quoted to say that “you could get the numbers to work” in reference to a transaction, which leads us to believe the beer giant is open to talks. Both AB InBev and SABMiller became giants of their respective industry via consolidation, and a tie-up is a natural extension. Though a merger of equals is certainly plausible through a stock swap, an acquisition of SABMiller will likely come with a premium in light of the company’s vast emerging-market opportunities.
Valuentum’s Take
Though the likelihood and timing of these two potential deals—Reynolds-Lorillard and AB Inbev-SABMiller—remains uncertain, and the antitrust considerations may result in divestitures at either combined entity, we like what the news means for Altria. In both cases, the investment case for Altria is strengthened. The company remains a position in the actively-managed portfolios.
Beverages – Alcoholic: BEAM, BF.B, BUD, SAM, BORN, CCU, STZ, DEO, FMX, TAP