Altria Group (NYSE: MO) has produced extremely strong performance for shareholders lately, posting average annual returns of more than 23% over the past five years. The company behind the world-renowned Marlboro brand has investors excited about its future, and signs of growth in its core cigarette business as well as in smaller businesses like smokeless tobacco and wine have inspired a record-setting run for the stock. Yet investors need to take one indication of Altria's attractiveness as an investment with a grain of salt, because it reflects a temporary situation that will go away over the next year. If you don't plan for that inevitable event, then you could find yourself unpleasantly surprised.
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Is Altria a value trap?
Recently, Altria has come up on many value investing screens as being a great buy at current prices. In particular, those who track price-to-earnings ratios have seen Altria appear quite frequently on their radar, and that's not terribly surprising in light of the fact that the tobacco giant's stock currently sports a trailing earnings multiple of less than 10.
Long-time investors in Altria are used to seeing relatively low valuations for the cigarette stock. The threat of litigation and other large liability events has loomed over Altria for years, and investors routinely forced Altria to suffer a significant discount to the market's earnings multiple in order to account for that increased risk.
Image source: Altria.
Yet today's low earnings multiples for Altria stem not from investor concern but rather from a one-time boost in the company's bottom line. Out of the $21.85 billion in pre-tax profit that Altria posted during 2016, nearly two-thirds -- $13.9 billion -- came from gains related to the combination of beer giants SABMiller and Anheuser-Busch InBev (NYSE: BUD).
How Budweiser boosted Altria's earnings
The nature of the SABMiller deal dictated Altria's tax exposure to the sale of its 27% stake in the company. Upon completion of the transaction, Altria received about 185 million restricted shares of Anheuser-Busch InBev stock, along with $4.8 billion in pre-tax cash as the cash component of the merger agreement. In addition, Altria had opened a derivative position in order to hedge currency risk from the deal, and that produced roughly $500 million in additional cash.
Most of the gain stemmed from the difference between the share price of Anheuser-Busch InBev on the day the transaction was completed and the book value at which Altria had carried its position in SABMiller. In addition, some further gain resulted from divestitures that Anheuser-Busch InBev did following the deal closing. As Altria noted, most of the gain from the merger was eligible for tax deferral treatment under U.S. corporate tax law, but to the extent that the tobacco giant received cash in exchange for a portion of its stake in SABMiller, it had to pay taxes on gains.
Altria's real earnings multiple
Once that one-time gain falls off the company's 12-month trailing earnings, Altria investors will see the stock's P/E ratio climb considerably. Already, investors are predicting that on a forward-looking basis, Altria's earnings multiple is likely to double to 20 by the end of 2017. That's above the market average even in an environment in which many see the overall market as being overvalued, and it reflects the desirability of Altria's consistent flows of dividend income and defensive characteristics.
Altria's new position in Anheuser-Busch InBev will provide an additional growth component to the company's core tobacco business, and investors are right to be excited about the opportunities that Altria's partnership with the beer behemoth will bring to its financial statements in the future. Nevertheless, Altria investors can't afford to think that they're getting a huge bargain for their shares based on current trailing earnings. Those who make that mistake will get a rude awakening when the effects of the SABMiller deal fade into the past later this year.
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