If at first you don’t succeed, try, try again is a pretty good maxim for life. But at what point do investors decide that a company has made too many mistakes? It is a very real question that needs to be asked Altria (MO 0.13%) as it looks to move on from disastrous investments in Juul and Cronos by purchasing Njoy. The big problem? It could be years before Wall Street knows how well the deal is working.
A brief look at the past
There is no doubt at this point that Altria faces a troubling future for its cigarette business. The company’s results for the whole of 2022 summarize the long-term trend perfectly. According to management: “Net revenue decreased 1.7%, primarily driven by lower shipment volume, partially offset by higher prices and lower marketing investments.”
Basically, fewer cigarettes are sold, but they cost customers more. It’s not a sustainable business model because at some point Altria will hit a tipping point where price increases become too onerous and end up causing more financial pain (increasing the sales decline) than benefit (offsetting the revenue lost from the declines).
Image source: Getty Images.
Management is not unaware of what is happening. First, it is very correct to treat the cigarette operation as a cash cow. To keep investors interested in the stock, it pays a huge dividend from the reliable, at least for now, cash flow this business generates. The dividend yield is an attractive 8% today. It’s also buying back shares, worth $1.8 billion in 2022 alone. A new $1 billion share buyback program was also announced.
In addition to this shareholder-directed effort, the company has tried to diversify its business into new areas. The two most notable moves here were an investment in marijuana company Cronos and another in vape maker Juul. While the concept behind these two moves was good, the result is where the problem lies.
Down and out
At this point Altria appears to have given up on both the Juul and Cronos. There have been several billion dollar write-downs associated with these deals, and there has been nothing material to show for them. Hindsight is 20/20, but management clearly made a mistake.
That’s the unfortunate backdrop for Altria’s current $2.75 billion investment in Njoy, another vaping company (there’s an additional $500 million provision for earn-outs based on product milestones). To be fair, Njoy is much further along in its business development than Juul or Cronos were when Altria stepped in for them in 2018. So it seems like it has a better chance of success today.
The problem investors must grapple with is balancing the reality of past failures with Altria’s timeline of success with Njoy. According to the press release describing the deal: “We expect the transaction to be accretive to cash flow within two years of closing and accretive to our adjusted diluted earnings per share (EPS) within three years of completion. We also estimate the return on invested capital for the transaction to exceed our current weighted average cost of capital within three to four years of closing.”
There will clearly be indicators both financially and operationally before Njoy starts adding (or detracting) meaningfully to (or from) top-line financial results. However, it’s hard to believe that management is going to be anything but positive as the business is integrated into Altria. So a pinch of salt is needed here.
To be fair, Altria has a lot to offer a smaller and less well-supported brand, given Altria’s size and reach in the tobacco industry. But that does not guarantee success although non-financial indicators (such as the number of outlets selling Njoy) are likely to be the main focus of management updates.
Down for a reason
Altria’s stock is down about 40% since its recent high-water mark in 2017. The big reason for the negative sentiment on Wall Street is the slow decline of Altria’s core cigarette business combined with its failed attempts to diversify. The steep selloff is why yields are so high, which may attract dividend investors looking to maximize their current income.
The dividend seems pretty safe right now, given the cash dividend of around 80% or so and the board’s current commitment to rewarding investors with dividends and buybacks. However, conservative investors who think in terms of decades have to worry about the company’s ability to continue paying such a large dividend over the long term, given its recent business results.
The Njoy deal looks relatively attractive compared to Juul and Cronos, but it might be better to wait for some concrete results before buying Altria based on this acquisition news. And if Altria ends up striking out again with Njoy, well, the high returns here probably aren’t worth the risk even if you have a short investment time horizon.
