WARNING: If you’re an investor looking for stocks that will soar in the economic recovery (if it happens), look elsewhere. But if you’re a patient investor willing to accumulate and hold a stock for years to get a good return, read on.
The basic investment case for Altria Group (MO), the holding company for Philip Morris, U.S.A., the largest domestic U.S. tobacco company, is strong—a well run company with good profit margins, an addictive product, and a nice dividend (7.77% yield at the July 10, 2009 closing price of $16.47). However, I believe that for investors seeking to capitalize on an economic recovery there are better picks. Rather, Altria’a value is more likely to be unlocked by changes in political winds not likely to shift for several years. Along the way, however, the downside is limited by political factors that will protect the industry.
Wall Street often misunderstands how public policy can affect value. (See my post on How to Make Money Investing in Stock by Arbitraging Wall Street’s Misunderstanding of Public Policy.) In this connection, two current long-term public policy trends depress the price of Altria’s stock. First is the political cycle. The Democratic party, which includes “tobacco abuse prevention” in its platform,1 is in power. Aside from winning the presidency in 2008, Democrats hold a 58-40 majority in the Senate and a 255-178 majority in the House of Representatives. While the President’s party usually loses ground in Congress during mid-term elections—on average 4 Senate and 28 House seats over the last seventeen– 2 the current margins are so high that Republican’s face an uphill battle to overtake either house in 2010. Moreover, facilitating some economic recovery by 2012 may assure President Obama a second term.
Second is the regulatory cycle. The Family Smoking Prevention Tobacco and Control Act was passed by Congress and signed by the President in June. The Act marks the culmination of a long-fought battle to subject tobacco products to the regulation of the U.S. Food and Drug Administration (FDA). Many of the Act’s restrictions will be defined through a regulatory process that will take years to complete. For example, the timeline under which the FDA must issue regulations for the marketing and promotion of non-face-to-face sales is 2 years3 Moreover, barring a special finding that an earlier date is necessary to protect public health, regulations for product standards cannot come into effect until a year after they are announced, and not for 2 years if they will change the method of farming domestic tobacco.4
So between the political and regulatory cycles, a pallor of uncertainty as to how new regulations will affect the U.S. tobacco industry is likely to hang over Altria’s stock price for years. That said, the Obama administration is highly motivated to steer the country towards economic recovery and get reelected. While several states have tobacco-related employment, the states with the greatest proportion of tobacco-related economic activity are North Carolina, Kentucky and Virginia.5 These three states currently have unemployment figures of 11.1%, 10.6%, and 7.1%, respectively.6 Moreover, North Carolina and Virginia are both important swing states that Obama won in the 2008 election, accounting for 28 of the 270 electoral votes he needed to win the presidency. Until 2008, both states had voted Republican in every presidential election since 1980, making it 32 years since a Democratic presidential candidate had won either state.
Thus, a perception that government regulation has sacrificed tobacco jobs in North Carolina and Virginia is something Democrats want to avoid. I am not at all suggesting that the Obama administration would inappropriately allow electoral considerations to be considered in the regulatory process or in other executive branch decisions concerning big tobacco, such as litigation positions. However, if you subscribe to the theory that people may act subconsciously with regard for their interests, it is reasonable to believe that policy and political motivations will keep administration policy makers away from outcomes too burdensome on domestic tobacco.
So, in short, while the political and regulatory cycles may continue to create a perception that the government is clamping down on big tobacco, the administration’s motivation to achieve both economic recovery and reelection will guard against real long-term harm. At some point circumstances will change—the new regulations will become defined and understood and eventually Republicans who are less likely to regulate industry will swing back into favor—unlocking Altria’s value. ((This post in solely an investment analysis and is not intended to indicate the author’s personal political perspectives or views regarding regulation of the tobacco industry.)) Long-term investors will be able to accumulate and reinvest attractive dividends along the way, leading to even greater gains when the stock price appreciates. Even if this doesn’t happen, with a prominent investment figure like Charles Schwab, founder of broker Charles Schwab (SCHW), being quoted as saying investors should expect 4% to 5% returns in the equity markets in the next four to five years,7 Altria’s dividends alone may outperform the broader market.
(Note: The author holds a securities position that is long on Altria Group as of the original publication date of this post. The author does not hold a securities position in Charles Schwab.)
- See The 2008 Democratic National Platform: Renewing America’s Promise, p. 11, http://s3.amazonaws.com/apache.3cdn.net/8a738445026d1d5f0f_bcm6b5l7a.pdf. [↩]
- http://en.wikipedia.org/w/index.php?title=United_States_midterm_election&oldid=286240820 [↩]
- See The Family Smoking Prevention Tobacco and Control Act, Sec. 907(d)(2), http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h1256enr.txt.pdf. [↩]
- See the Family Smoking Prevention Tobacco and Control Act, Sec. 906(d)(4)(ii), http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h1256enr.txt.pdf. [↩]
- See Lan Liang, Frank J. Chaloupka, and Kathryn Ierulli, Measuring the Impact of Tobacco on State Economies, p. 176-77, in EVALUATING ASSIST–A Blueprint for Understanding State-Level Tobacco Control, October 2006, http://cancercontrol.cancer.gov/TCRB/monographs/17/m17_6.pdf. See also H. Frederick Gale, Jr., Linda Foreman, and Thomas Capehart, Tobacco and the Economy: Farms, Jobs, and Communities, Economic Research Service, U.S. Department of Agriculture, Agricultural Economic Report No. 789, http://www.ers.usda.gov/publications/aer789/AER789.PDF. [↩]
- See http://en.wikipedia.org/w/index.phptitle=List_of_U.S._states_by_unemployment_rate&oldid=301325806 . [↩]
- See Leslie P. Norton, “Chuck’s Big Chance,” p. L4, in Barron’s, July 13, 2009. [↩]