Altria  Group,  Inc.  –  Update

Group 5: Michelle Darmawan Zhang Chenxi Manasvi Garg Archit Ajit Sharma Ho Qian Ying Adeline

Disclaimer

This study is purely for academic purposes. All investments are subject to market risk. Please read the report carefully before investing. The group shall not be held responsible for any loss made by following the recommendations made in the following sections.

ALTRIA – The Company

•  Introduction •  Industry Overview •  SWOT Analysis •  Financial Ratios •  Long Term Financing Structure •  Stock Analysis

• RECOMMENDATIONS

Subsidiaries

1. Phillip Morris USA Inc.

2. U.S. Smokeless Tobacco Company

3. Ste. Michelle Wine Estates Ltd

4. John Middleton Co.

5. Phillip Morris Capital Corporation

Business Segment Overview

1. Cigarettes

2. Cigars

3. Smokeless Products

4. Wine Products

5. Phillip Morris Capital Corporation

85%

3% 6%

2% 4%

Net Revenue Breakdown by Business Segment

Cigarettes

Cigars

Smokeless Products

Wine Products

Phillip Morris Capital Corporation

Competitive Landscape

1. Declining smoking consumption

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"

"

"

"

"

"

"

2. High Tax Rate

3. Highly susceptible to litigation

• Insurance program reauthorization act of 2009 drastically increased taxes on tobacco products to provide funding for government-sponsored health insurance for illegal aliens and low-income families

4. New opportunities for growth e.g. smokeless products and wine

Major Players & Competitors

1. Reynolds American, Inc. (RAI)

2. British American Tobacco PLC. (BTI)

3. Phillip Morris International (PM)

SWOT Analysis

STRENGTHS 1. Largest Tobacco Manufacturer 2. Company is well established 3. Company stock is generally not volatile, with a beta ratio of only 0.43

WEAKNESS 1. Declining smoking rates 2. Cigarettes are the only driving force in company 3. High competition

OPPORTUNITIES 1. Acquisitions can be extremely profitable 2. Smokeless products proved to be growing trend in consumers.

THREATS 1. Illegal brands can compromise market share 2. High taxes can threaten growth 3. Social pressures discourages smoking.

FINANCIAL STATEMENT ANALYSIS

Profitability

0%

5%

10%

15%

20%

25%

30%

35%

2008 2009 2010 2011 2012

Altria

Reynold

Lorillard

NET PROFIT MARGIN

Dividends

0%

20%

40%

60%

80%

100%

120%

2012 2011 2010 2009 2008

Altria

Reynold

Lorillard

0%

2%

4%

6%

8%

10%

12%

2012 2011 2010 2009 2008

Altria

Reynold

Lorillard DIVIDEND PAYOUT RATIO

DIVIDEND YIELD

Industry average: 3.4%

Return on Assets & Equity

RETURN ON EQUITY

RETURN ON ASSETS

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

2008 2009 2010 2011 2012

Altria

Reynold

Lorillard

0.00%

50.00%

100.00%

150.00%

200.00%

250.00%

300.00%

2008 2009 2010 2011 2012

Altria

Reynold

Lorillard

Liquidity

0

0.5

1

1.5

2

2.5

2008 2009 2010 2011 2012

Altria

Reynold

Lorillard

CURRENT RATIO

0.0

50.0

100.0

150.0

200.0

250.0

300.0

2008 2009 2010 2011 2012

CCC

Days Sales Oustanding Avg days in Inventory Days payables Outstanding

Components of Altria Cash Conversion Cycle

Efficiency of Cash Conversion

0.000

50.000

100.000

150.000

200.000

250.000

300.000

2008 2009 2010 2011 2012

Altria Reynold Lorillard

Comparisons of Cash Conversion Cycle

Efficiency of Cash Conversion

Comparison of Debt-to-equity Ratio

Solvency

-10

-8

-6

-4

-2

0

2

4

6

8

10

2008 2009 2010 2011 2012

Altria

Reynold

Lorillard

LONG-TERM FINANCING

Capital Structure

Long-term Debt to Equity  

Total Debt to Equity  

Total Debt to Assets  

12,419 / 3,168 = 3.9201  

32,161 / 3,168 = 10.1518  

32,161 / 35,329 = 0.9103  

Debt > Equity

Cost of Capital

g = 2% D1 =1.880 P0 = 31.44

Cost of Equity =

7.98%

Cost of Debt = 6.7%

Cost of Capital Weighted Average Cost of Capital (WACC)

wdrd(1-T) + wprp + wsrs

(0.9103)(0.067)(1-0.296) + (0.0897)(0.0798) = 0.04293 + 0.00715806

= 5.009%

Low WACC Good investment

STOCK ANALYSIS

Stock Price Analysis

Stock Price Movements of Altria from May ‘11 to March ‘13

Investment Risks •  Premium Brand Sale Decline

• Adverse Litigation and Legal Issues

• Decrease in Consumer Demand ▫  Public awareness of health risks associated with

smoking ▫  Social acceptability of smoking

• Government Regulation ▫  Cigarette taxes ▫  Restriction on Smoking

Quantifying Risk

• Capital Asset Pricing Model (CAPM): ▫  Risk free rate: Rf = 2.04 (10yr US Treasury Bond Yield) ▫  Cost of Equity/Return: Rs = 1.880/31.44 + 0.02 = 7.98%

β: 7.98=2.04+β (RM-RF) where Rf =2.04 and Rm = 16.40

β =0.41

Stock Valuation

Absolute Valuation Model

“True" value of a firm

based on the dividends

DIVIDEND GROWTH

MODEL

PRICING MULTIPLES OF OTHER

FIRMS

Relative Valuation Model

P/E ratio focuses on earnings of the company, which drives investments

value

Dividend Growth Model

$35.85: Undervalued by 14.03% taking $31.44 as current stock price

Terminal growth rate = 2% Steady State – Year 6 onwards

Multiples of Other Firms •  Lorillard Altria EPS x Lorillard PER

2.21 x 13.84 $30.59

•  Reynolds American Altria EPS x RAI PER

2.21x 18.50 $40.89

Average Stock Price: $ 35.74

VERDICT

• UNDERPRICED

ALTRIA STOCK

Sensitivity Analysis •  Stock price vs. Terminal growth rate (g) and COE (rs)

               

Terminal  Growth  rate  

(g)  

Cost  of  Equity  (rs)       7.68%   7.78%   7.88%   7.98%   8.08%   8.18%  

1.25%   29.24   28.79   28.36   27.93   27.53   27.13  

1.50%   30.42   29.94   29.47   29.01   28.57   28.14  

1.75%   31.70   31.18   30.67   30.18   29.70   29.24  

2.00%   33.10   32.53   31.97   31.44   30.92   30.42  

2.25%   34.62   34.00   33.39   32.81   32.25   31.70  

2.50%   36.29   35.61   34.94   34.31   33.69   33.10  

Results

•  Stock price of the Altria group is very sensitive to changes

•  Terminal growth rate of 2% roughly matches the forecasted growth of the US economy

�  Altria stock price should remain stable

RECOMMENDATIONS

RECOMMENDATIONS Consistently strong performer Undervalued according to both methods Commanding industry position Regular dividend payouts Unlikelihood that any new tobacco rivals will emerge No. 1 in the sales in the US tobacco market

BUY for the Altria Group, Inc.’s stock in the short term.

HOLD in the long term

Uncertainty surrounding the tobacco industry Low terminal growth rate of 2% Highly sensitive to the terminal growth rate Cigarette sales constitute a massive 85% share of Altria’s sales revenue Growing inclination of consumers towards smoke-free cigarette substitutes and smokeless products

RECOMMENDATIONS