There's nothing wrong with a cash-cow business, which is exactly how many investors view Altria Group(NYSE: MO). That might not be the right way to look at it, however, given the long-term trends in smoking, the company's primary market.
And then you have to consider what management has done as it looks to replace its slowly declining cigarette operations. Sure, the 8.3% yield is enticing, but there's likely more risk here than many expect.
Milking the cow dry
Cash-cow businesses are often mature and grow slowly, with the primary benefit being that they are reliable profit generators. Managed carefully, such operations can continue on for a very long time.
In fact, many consumer staples brands would fall into this category and have sustained long-term success at companies like Procter & Gamble and Kimberly-Clark. Altria's cigarette business kind of seems like the same thing, but it's not.
Image source: Getty Images.
To put it simply, toothpaste and toilet paper are staples for just about everyone, while cigarettes are not. Moreover, nobody is all too worried about the impact of the first two on their health, but most people are worried about the effects of smoking.
The number of smokers fell from nearly 21% of the U.S. population in 2005 to just 12.5% in 2020, according to the U.S. Centers for Disease Control and Prevention (CDC). Basically, the market for cigarettes has steadily shrunk while the market for true consumer staples is likely to grow along with the U.S. population.
This is a problem for Altria because it pays a huge dividend; the yield today is a very generous 8.3%. And while the dividend payment has been increasing, the company's payout ratio, which looks at dividends relative to earnings, has been above 100% for several years. To be fair, dividends are paid out of cash flow, not earnings, so this isn't a death knell for the dividend, but it is a warning sign that dividend investors should be digging into the company a bit deeper.
More bad news
On the positive side of things, the cash dividend payout ratio, which compares dividend payments to cash flow, has been fairly consistently in the 80% range in recent years. So the dividend looks sustainable, noting that the company's customers tend to be willing to accept steadily increasing cigarette prices.
But the difference between earnings and cash flow is actually quite important from a business point of view. Part of the company's earnings weakness relates back to one-time charges reducing the value of investments the company has made in businesses that management hoped would provide new avenues for long-term growth. Specifically, Altria invested in vape company Juul and cannabis company Cronos(NASDAQ: CRON). Neither has worked out as planned.
So the deeper story here appears to be that Altria can afford its dividend only as long as it can continue to push higher prices onto a shrinking customer base. And it hasn't been successful at finding a new line of business to replace the cash cow that it is, most likely, milking dry.
The roughly 20% drop from early 2022 highs is most likely tied at least partly to the broader market's decline. The over 40% drop since its 2017 peak? Well, that's likely a reflection of the bigger problems the company faces, noting it represents a vast relative underperformance compared to the S&P 500.
Not a long-term holding
Altria's huge dividend yield is certainly enticing and looks supportable over the near term. The problem is that the business model that allows it to pay the current dividend doesn't appear to have a strong long-term cash cow cigarette operations to find a replacement. If you think in decades, the company doesn't look like a good buy even after a big sell-off.
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Reuben Gregg Brewer has positions in Procter & Gamble. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
