Video Update: What Happens When Even Our Picks Aren’t Free From Volatility

The market has faced a lot of volatility in the past month. And our picks haven’t been immune to it.

However, we select our recommendations to help withstand this volatility.

That’s why when one of our Fortress picks fell 8% in the last few days, we wanted you to be the first to know why.

In today’s update, Chief Analyst Adam Galas goes over the news about one of our favorite long-term holdings… and reiterates our thesis for its stalwart business.

Click the image below to watch the video or scroll down to read the transcript.

Happy SWAN (sleep well at night) investing,

Brad Thomas Editor, Fortress Portfolio

Welcome, Fortress Portfolio members to another weekly video update.

Now, I know we've been saying that we're going to talk about the economy and the impacts that it will have on your Fortress Portfolio. And we certainly will because that's important.

But – we had late breaking news last week with Altria (MO) falling 8% in a single day.

Now, I'm sure that many of you noticed and were wondering – is the resulting almost 10% yield a sign of a broken company? Or the buying opportunity of a lifetime?

So that's what this video is about, to help you make the best decision for your needs.

So let's talk about that.

Altria fell 8.3% after missing both the sales and earnings projection estimates.

Now with a yield of 9.7% and a price to earnings ratio of just 7.9... What does this actually mean?

It means the stock is now pricing in -1.2% growth forever.

It's what we call an anti-bubble stock, meaning that it's impossible to lose money over the long term as long as it grows faster than zero – and you can avoid selling it for emotional reasons.

These emotional reasons include selling Altria out of disgust at its drop in share price, or from a lack of understanding and poor risk management, and/or having to sell shares to pay the bills because you can’t live purely on the income from its dividend and others in your portfolio.

But what actually happened with Altria’s earnings?

Adjusted earnings came in at one penny less than expected... $1.28 rather than its previously estimated $1.29.

So basically, no change there…

And next year’s growth outlook fell from 4.6% to 3.6%... So down just 1%.

But, the yield is so much higher…

And if you're buying it today, it's still a 13% to 14% long term return potential.

That is 1% more than we expect from the Nasdaq. And 3.5% more than the S&P historically does… and is expected to deliver in the future.

Now, let's remember that Altria is an investor company that is 100% all about its dividend… and has been for the last 54 years – the length of its dividend growth streak.

And Altria’s management team has been safely raising that dividend through hell and high water – 15% inflation, interest rates of 20%, a pandemic, the Great Recession… And of course, we can't forget the 1998 Master Settlement Agreement in which the tobacco industry agreed to pay $206 billion to the United States for causing cancer and hurting our health over the decades.

Now in the future, the industry has agreed – smoke free and cigarette free is the future.

We're talking about vaping, heatsticks, oral nicotine pouches, the reduced risk products, and possibly even cannabis.

Now the good news is – financially speaking – nicotine itself is not a dying industry.

Just take a look below. You can see we're looking at around $400 billion globally per year with sales growing at 13% annually.

And we are expected to hit around $1.2 trillion by 2031.

(Source: Business Research Insider)

But don't get too excited… because about 50% of that is China. And China's government does not allow foreign companies to sell to their people.

Now, the good news is globally and in the United States, nicotine is growing around 4% to 5% per year. As people are switching from cigarettes to reduced risk products.

In terms of investing in tobacco companies like Altria, the questions to be asking are – Can they make this transition smoothly? And, do they have enough time to keep raising those dividends safely while they shift to becoming a big nicotine provider rather than big tobacco?

Now, to answer that, Morningstar has done a study.

They looked at the prices of cigarettes around the world.

As you can see below, in Australia cigarettes are $26 a pack because of the highest taxes in the world.

(Source: Statista)

The United States is much lower at $9.

 And as prices change, the demand for cigarettes in these countries change.

Now, Morningstar estimates that Altria in the United States has about 20 years before they can no longer keep hiking prices to offset volume declines.

That's how sales have kept growing steadily, though slowly, even though volumes have been falling for the last 50 years.

Now, of course, every model makes assumptions, and this is where you have to prove your model in the real world.

And this is where Altria ran into a problem in the last few quarters.

Last Thursday, they reported that in the third quarter, sales actually fell by 4.4%.

And they're down 2.5% year to date.

Earnings per share (EPS) for the quarter was flat and year to date is up 3.3%.

Now, the issue is this, Altria hasn't reported negative sales in the last 20 years – with the exception of 2007 when they spun off Kraft.

Now, the good news for 2023 is that after these bad results analysts are now expecting that sales will fall just 0.3% for the year and then gradually start increasing to new record highs… with around 0.8% annual sales growth through 2027.

(Source: Altria Sales Forecast via FactSet)

For context, in the last 20 years, sales were growing at 2.5%. So you can see this is slower growth.

So the question is – what does this mean for the dividend, especially its dividend safety?

Well, as you can see below, there is no dividend cut expected. The dividend is expected to keep growing at around 3.5%, about the same rate as its earnings.

(Source: Altria Dividend Forecast via FactSet)

That's actually by design.

Altria’s management team has a policy of trying to payout 80% of earnings as the dividend.

Right now, the payout ratio is 77% and it's expected to fall to 75% by 2027. For context, rating agencies consider up to 85% a safe payout ratio for this industry.

Now, when we recommended Altria, it was yielding about 9% back in May.

So if you bought it then or any time since (with a yield that's been steadily growing higher at 3% to 4%), long term dividend growth still means 12% to 13% returns.

So Nasdaq level returns but swimming in income from those dividends.

Now, we bought it for and recommended it at $45 back in May. We are down about 7% so far. And that's completely due to the decline in response to recent earnings.

Now, this all sounds good, but what about a potential hard stop?

Ours is about $31.78, and we're confident Altria will not fall that low.

In that case Altria’s share price would have to drop down to 7x earnings and a 12% yield, which hasn't happened since the Great Recession.

Now, is it possible? Sure.

It always is.

And there are some valid risks that the market picked up on and that we're watching with Altria.

It sold off 8% because of some very troubling trends.

Now, as you can see, the decline volumes for the entire cigarette industry have accelerated in this period of high inflation from a normal 4% to 5% (that management expects long term) to 8% to 9%.

(Source: Altria’s Latest Earnings Presentation)

Now, this is because inflation is so high that people are having trouble paying for other things.

As you can see below, Altria’s management is providing its own model for what's causing these accelerated volume declines.

(Source: Altria’s Latest Earnings Presentation)

They think about 4% or roughly half of the decline acceleration is from things like inflation.

Now, the problem for Altria is that it's a premium brand. So as you can see below, in the last few quarters they've reported 10% volume declines.

(Source: Altria’s Latest Earnings Presentation)

Now, normally they raise prices fast enough to get over those volumes and keep revenues growing as well as sales growing at a positive rate.

So far this year, they've raised prices by 7.5%, which is quite high... but not enough to offset those volume declines.

Now, in the future, management is saying there will be 4% to 5% declines, and analysts think that's reasonable based on their models.

Our model also says that is reasonable.

So all the experts basically agree.

Now, what about the actual threat to the company itself?

Because remember, fundamental risk analyzes the risk of buying a stock and then watching it go to zero.

Well, we have the bond market giving us real time daily updates as news breaks.

So we can see that in the last week, the risk of Altria going bankrupt and the stock going to zero went up about 3% in the last three months.

(Source: Altria CDS via FactSet)

It's up about 20%, but still only up to 1.1% – about 3.3% over the next 30 years.

That is consistent with an A-minus credit rating.

Now, the S&P rated it BBB with a positive outlook. They’re actually bullish on the long-term prospects for Altria.

So we're not worried about this company's fundamental health. We're focused like a laser on the dividend.

Now, what does this mean for the dividend safety?

Well, our 3,000-point safety and quality model (which we’ve talked about in recent weeks at length) says that – if Altria were to continued growing at a negative rate as it did this quarter for several years – then the dividend at some point would have to be cut.

So right now we have Altria categorized at what we call a negative outlook, meaning that if positive growth doesn’t return in the coming quarters like management and analysts say, the safety score will steadily fall to 55%.

Now, what does that mean from a current 100% safety score?

Well, 100% does not mean dividend safety is guaranteed. It simply means that even in a severe recession like the pandemic, the risk of a cut is 1%.

Now, a 55% safety score would mean a 7% risk of a cut. So you can see a significantly higher risk, but still not a base case event.

So essentially the thesis is weakened but not broken.

We're simply watching carefully to make sure that management can deliver that positive growth they say they can in the coming quarters.

Now should you be buying Altria at this time?

Well, that depends on your risk profile and how much you already own.

As you can see below, if Altria grows at a modest 4% in 2024, and 4% in 2025, and then returns to its historical fair value of 14 times earnings – that is a 110% upside potential – 42% annually.

(Source: FAST Graphs)

For context, the S&P is expected to go up just 20% in the next two years.

That’s 5.5X the return potential over the S&P because it's trading at the best valuations since the Great Recession.

So if you don't have a full position, the bottom line is – now is an absolutely amazing time to buy it.

Thank you for joining us for this special report, covering this incredible opportunity with Altria.

I hope you can see why you should sleep well at night. Even when scary headlines break, we're on top of it.

We have the tools. We have the expertise. We know what to look for to make sure your money and your income are safe. And to help you retire in safety and splendor.

I hope you join us next week when we provide some more context about what's going on in these challenging times and what it means for your Fortress Portfolio.

Please send us your questions and feedback so I can respond to them in these videos and our monthly issues. Just remember, I can't provide personalized investment advice.

Until next week, this is Adam Galas wishing you and your family safe investing and a healthy and relaxing weekend.