Title: Altria Can be Saved by Its Sister

Summary:

#1 Altria is stuck with a highly profitable product with less and less consumers to buy it.

#2 Management is making serious effort in diversification.

#3 Philip Morris innovative heated tobacco products may become a serious growth vector.

9 years ago, Altria (MO) has made the decision of “unlocking” value for shareholders and spun-off its international division into Philip Morris International (PM). While the number of cigarette smokers is growing throughout most emerging markets, it’s the opposite situation happening in the U.S. where MO is active. While the company is making serious money, where could it go in ten years from now if its clients are disappearing one after the other? Its sister company may have found the solution. Let’s dig into Altria to discover if its worthy of your portfolio.

What Makes Altria (MO) a Good Business?

Altria is one of the largest producer and distributor of tobacco products. These products are highly profitable and lead to repetitive sales. Over the years, regulations around marketing and branding of tobacco products have somewhat protected MO major brands from erosion. Since then, MO benefits from a competitive advantage as its brand is very strong and no marketing can hit it.

However, since the number of American cigarette consumers is decreasing, MO has been working on diversification. Their efforts resume into acquiring 10% of BUD, creating e-vapor brands and operating Ste. Michelle Wine Estates, their smallest but also fastest growing business segment.

Source: 2016 MO investors highlights

However, these efforts haven’t changed MO business model that much:

Author’s table, 2016 annual report numbers

Revenue

Revenue Graph from Ycharts

Since the spin-off, Altria is showing consistent growing revenues. The company benefits from strong pricing power to support this growth. Unfortunately, the reality will hit Altria sooner or later:

Source: Centers of Disease Control and Prevention (CDC)

The number of smokers is clearly decreasing in the U.S. Altria is well aware of this situation and this is why management is looking for diversification. A new hope has risen since PM has developed a new kind of product called IQOS system.

Instead of burning the tobacco, this innovative version of the e-cigarette is heating it. The product is currently being under FDA review to determine which kind of product regulations and taxes will apply to it. MO has the exclusive right on this technology in the U.S.

How MO fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

MO has always been generous with its shareholders. You can see that as the dividend grew over the past 5 years, MO yield tend to go down. This is because the stock surged by 105.78% over the past 5 years (as at July 19th 2017). At over 3%, MO remains a very interesting stock.

MO meets my 1st investing principles.

Principle#2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Source: Ycharts

Altria has increased its dividend 50 times in the past 48 years. This make the company part of the dividend achievers lists. The Dividend Achievers Index refers to all public companies that have successfully increase their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

MO meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

Please note the reason the payout ratio goes went down dramatically is because of the gain realised on AB InBev/SABMiller business combination. In other words, this is a one-time adjustment that should not be considered.

Therefore, the “real” payout ratio is more about 80%. While I’m satisfied with a 80% payout ratio, I will pay a close attention to it in the future.

MO meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

The core business of MO has been and will remain tobacco products. While Altria benefits from a strong branding and the pricing power that comes with it, its number of clients is decreasing year after year. Additional growth vectors must be added to the equation before it’s too late. The 10% participation in ABInBev, the increasing wine segment and the potential of heated tobacco are enough factors for me to consider Altria a growing company for now.

MO still shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect timing to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is a valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

If you ignore the recent PE drop due to special item in their most recent quarter, MO is being traded at an ever increasing PE ratio. While I understand the attractive perspective of MO cash flow generation abilities, I start to think it is overpriced.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I rather see companies like big money making machine and assess their value as such.  I think MO is able to maintain a 8% dividend growth rate for the first 10 years as MO is generating lots of cash flow and has the possibility to market IQOS (pending FDA approval). However, I reduced the terminal rate to 5% as I don’t think revenue growth will be that strong in the future. Since MO revolves in a very stable and mature market and future cash flow are relatively predictable, I used a discount rate of 9%.

Here are the details of my calculations:

Source: how to use the Dividend Discount Model

MO is showing a 10% upside potential at the moment. However, this is assuming a FDA approval for the IQOS system.

MO meets my 5th investing principle with a 10% upside potential

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company  are not valid anymore, I sell and never look back.

Investment thesis

A leading company in a well-protected market is always a good source of cash flow. Altria can continue generating cash for shareholders for several years to come. While growth factors are interesting but not incredible, the outcome of the IQOS system on the market will be crucial. However, regardless of this option, MO is still a solid dividend payer that will continue increasing its payout for the next decade.

MO shows a solid investment thesis and meets my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Altria evolves in a mature market with highly predictable outcome. Considering its strong dividend payout history, MO could be part of a core holding for income seeking investors.

MO is a core holding.

Final Thoughts on MO – Buy, Hold or Sell?

While Altria meets my 7 dividend growth investing principles, I’ve decided not to pull the trigger on this one. I’m not too keen about the tobacco industry and sales could erode faster if the company doesn’t come with new products in the next decade. I respect its dividend growth potential, but I will leave MO to other investors.

Disclaimer: I do not hold MO in my DividendStocksRock portfolios.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Tractor Supply Stock Plunged, Time to Buy

Over the past 12 months, Tractor Supply (TSCO) stock price has suffered greatly with a drop of 45%. At the same time, revenues, earnings and dividend payments are showing a very strong uptrend. As the stock now yields over 2%, the company caught my attention. The following analysis will tell you why I think TSCO is a buy. However, nothing is perfect, and there are also risks of catching a falling knife.

What Makes Tractor Supply a Good Business?

Tractor Supply is the largest rural lifestyle retailer in the U.S. Founded in 1938, it now shows nearly $7 billion in sales and operates 1,700 stores across 49 states. They offer a wide variety of products: (1) equine,(2) hardware, (3) seasonal products, (4) work/recreational clothing and footwear and (5) maintenance products for agricultural and rural use.

Source: TSCO 2017 presentation

While TSCO competes with other big box retailers such as Home Depot (HD), Lowe’s (LOW), and Walmart (WMT), the company differentiates itself by focusing on rural areas (vs urban and suburban like the others), offering higher-end products and targeting farm owners, ranchers, and horse owners to build their client base. TSCO also offers a wide variety of products specifically engineered for the “do-it-yourself” customers.

Revenue

Revenue Graph from Ycharts

TSCO shows a very impressive revenue growth rate over the past decade. However, it is important to differentiate total revenues and comparable sales growth. The latter is a lot less impressive as stated in  TSCO most recent quarterly update:

“The decrease in comparable store sales was primarily driven by lower sales of seasonal merchandise and the impact of deflation. On a regional basis, sales were most challenged in the Northern regions, where weather had a more pronounced impact on sales for the quarter. The weakness in seasonal categories was partially offset by a positive comparable store sales increase in the Livestock and Pet category.”

Source: April 26th 2017 Press Release

The thing is TSCO focuses massively on growing its number of stores across the U.S. to sustain its growth. Management objective is to grow from 1,606 TSC stores in 2017 to 2,500. You can imagine how fast total revenues will continue to grow in the upcoming years.

Source: TSCO 2017 presentation

Unfortunately, if comparable store sales growth continues to slow down, there is no point in getting excited by TSCO revenue trend.

How TSCO Fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

Considering a yield below 1% since the beginning of its dividend history, TSCO has always been flying under my radar until recently. At first glance, the recent stock price drop created an interesting opportunity for dividend investors as currently the yield is now around 2%. If the company shows it can sustain its dividend growth trend, it will certainly become a very interesting dividend play.

TSCO meets my 1st investing principles.

Principle#2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Source: Ycharts

Tractor Supply started paying a modest dividend in 2010. Each year, management has successfully increased its payout since then. 2017 is the 6th consecutive year with a dividend increase. While the company started with a small yield, it shows a strong uptrend since the beginning.

TSCO meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

TSCO requires lots of cash flow to support its growth as management invests between $250M to $300M to grow its stores number (TSCO 2017 presentation). Still, the company has managed to control its payout ratio around 30% and its cash payout ratio between 35% and 65% since it has started to reward shareholders with dividends.

Management benefits from lots of room for future increase, opening the door for another decade of strong dividend raises. Dividend growth investors should not worry with TSCO for the next decade.

TSCO meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

Past numbers are always interesting to analyze, but it doesn’t necessarily tell you what is coming up next. A company with a strong business model will be able to evolve accordingly and continue to provide value to its shareholders.

TSCO is also well aware of the Amazon (AMZN) wave that could hurt its future growth. For this reason, management has focused on improving their digital marketing by enhancing their website search capabilities, creating a mobile centric application and developing an “order online, pick-up in store” offer.

On the other side, TSCO is somewhat shielded from the online wave at the moment due to several products being too heavy to be shipped at a competitive price. By focusing on rural or do-it-yourself customers, TSCO benefits from a solid and loyal client base.

With the opening of a new distribution center in New York by 2018, the company will also be able to improve its margins with lower distribution costs.

Lastly, Tractor Supply is also protecting a part of its business against ecommerce giants by promoting private label and exclusive brand products. If you can’t find it online, then you have to come to TSCO to buy it.

TSCO still shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect timing to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

With the most recent stock price drop, TSCO looks like a very attractive buy. However, let’s keep in mind that TSCO sales per store aren’t growing at the moment and most of their revenues and earnings growth is directly attributable to new stores opening. At one point in time, TSCO risks market saturation and cannibalization of its own stores.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I rather see companies like big money making machines and assess their value as such. I expect a strong dividend growth rate for the next 10 years reflecting the company’s store expansion across the U.S. Then, I think TSCO will have to go back to a more conservative growth rate. Since the company is well established and it is a leader in its industry, I use a discount rate of 9%.

Here are the details of my calculations:

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

Using the DDM, I get a fair value at $61.77. I think it makes sense as there is definitely a wind of panic around TSCO that is not justified at the moment.

TSCO meet my 5th investing principle with a potential upside of 20%

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell their holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company  are not valid anymore, I sell and never look back.

Investment thesis

An investment in TSCO is a statement of confidence in management’s ability to reverse same store sales growth trend while pursuing their ambitious growth plan. Management shows a steady usage of its cash flow rewarding shareholders with growth and dividend payouts:

Source: TSCO 2017 presentation

I think TSCO is a strong player in their narrowed niche which makes it very difficult for other competitors (HD, LOW or online giants) to grab their market shares. While other online companies will have a hard time competing due to shipment costs of heavy items, TSCO offers a great solution to their customers with their “order online, pick-up at a store” feature.  There is room for improvement in margins and this is why management will open a new distribution center in 2018.

The only thing missing for TSCO stock to rise again is stronger same store sales growth. This could be achieved through a good product mix and improvement to their loyalty program.

TSCO shows a solid investment thesis and meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

In ten years from now, it will be hard to find aggressive growth potential for Tractor Supply as all rural areas will likely be covered. In the meantime, I think the company will benefit from a strong stock price uptrend the minute their sales are going back into positive territories. This play incurs additional risks due to the current situation, but I believe TSCO has enough cards in its hand to win its bet.

TSCO is a growth holding.

Final Thoughts on TSCO – Buy, Hold or Sell?

Catching a falling knife is always a tricky operation. However, after reviewing the company’s fundamental and growth potential, I believe TSCO has reached the bottom and offers an interesting play for dividend growth investors. TSCO is a BUY.

Disclaimer: I do not hold TSCO in my DividendStocksRock portfolios.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

4 Things You Must Do to Protect Your Portfolio from The Next Crash

Over the past 5 years, the stock market has pretty much never stopped increasing:

Source: Ycharts

Between June 20th 2012 and June 20th 2017, the S&P 500 total return is getting us a very nice round number of 100%. In other words; the stock market doubled in value over the past 5 years. We are talking here about a compounding return rate of almost 15% per year during this period. Unfortunately, while the market doubled, the average P/E ratio keeps going up leading to think there is some bubble growing up:

Source: Factset

In the light of both graph, it seems obvious the market is going all the way up for the wrong reasons. There isn’t enough value being created at the moment to justify such hike in price. Does it mean you should sell your stocks and wait on the sideline? This would probably be the biggest mistake you could make. However, this doesn’t mean you have nothing to do to protect your portfolio from a potential crash. Here’s a list of what I’m doing now on my own portfolios:

#1 Review your asset allocation to spot any discrepancies

This is a common step that is often ignored by DIY investors. Did you know the biggest source of losses in portfolio is related to your asset allocation? Each time I came across an investor who lost lots of money, the common theme was the same: the bulk of their investment was in a single industry. As the stock market rose, some industries did better than others. If you haven’t done much trades in the past year and simply looked at your portfolio growing, chances are you are over weighted in some industries.

Therefore, my first step to review my portfolio is to create a simple Excel pie chart using the company name, sector and current value.  Within a few minutes, my pie chart is ready and I get a clear view of what my portfolio looks like:

Source: DSR portfolios returns

You can then easily determine if your asset allocation makes sense or not and identify over weighted sectors where you will need to make transactions.

#2 Review each holding with your initial investment thesis

To facilitate the selection of companies to trade, I then review each of my holdings and look at my initial thesis. Each selection in my portfolio has been made based on my 7 dividend investing growth principles. This is a set of seven investing rules based on decades of academic studies and my own experience as an investor. Principle 6 focuses on the importance of having a strong investment thesis before making any purchases. Once you have identified the reasons why you think a company should be part of your portfolio, it makes it easy to follow it throughout time. Each year, I review my investment thesis to make it still make sense today. As an example, here’s my investment thesis for Lockheed Martin (LMT):

“One of the reasons why I like LMT so much is that it  evolves in a quasi monopoly. They obviously have lots of competitors, but LMT has become THE defense company the U.S. government goes to when it comes down to jet fighters for example. Lockheed Martin has done what BlackBerry did a few years ago by controlling the market. Fortunately for them, it is a lot harder to copy an F35 than a smartphone!

“LMT clients are closely bonded to them for several reasons. First, the trust between both the client and the company is quite important in this case. We are talking about military defense, you will not change your supplier in a heartbeat! Second, the switching cost for their clients would be incredibly high. Lockheed Martin benefits from several long-term contracts guaranteeing a steady income flow. Those contracts are not easily broken. Plus, LMT owns a unique experience in military defense products and services.

“It seems LMT is surfing through the perfect storm. As conflicts are rising around the globe, the Congress accepted Lockheed Martin to seek out for international opportunities. This means the company could enlarge its international sales by doing business offshore.”

Source: The Dividend Guy Blog

As long as LMT will go along with my thesis, I will hold onto this stock. If the business model changes or the industry is not the same anymore, I will not hesitate to pull the sell trigger.

#3 Use a proper valuation model

My third step is to use a valuation model that will help me making my trading decisions. In my opinion, the investment thesis weights a lot more than any valuation model. The main reason being is any kind of valuation model is as good as your assumptions. Unfortunately, it is very easy to make mistakes.

I use a double stage dividend discount model. As a dividend growth investor, I rather see companies like big money making machine and assess their value as such. I think the company will reduce slowly its dividend growth rate compared to previous years as it is clearly unsustainable. Here’s an example of metrics I used to value 3M Co (MMM) another of my favorite holding.

And the calculation results:

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

The Dividend Discount Model doesn’t own all the answers, but it is a very powerful tool to asses the value of a stock while it is included in a complete investing process.

#4 Make trades, but don’t panic

I know, the temptation of selling your stocks with profit and waiting on the sidelines for the next market dip is very seductive. However, as we never know how Mr. Market’s mood swings will affect our portfolio (we could definitely see another bull market for the next 3 years), I rather have most of my money well invested and cash dividend payouts every month.

The key is to make light changes, tweaks, to your portfolio to make sure your money is well invested. This is not a time to panic nor selling everything you hold. I personally did one trade so far in my portfolio as one of my holding didn’t meet my investing thesis anymore. I might do another one but that’s about it. It’s never a good move to panic or make massive move with your portfolio.

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Disclaimer: I hold LMT & MMM