Thursday, February 1, 2007

Altria Shareholders (MO)- Dump Your Kraft Shares

I know, I know, typically in a spin off situation the shares of the company being spun off outperform the market. But, this is no typical situation. In a normal spin off the parent company feels the segment being spun is not being fully valued in the price of the parent companies shares (see the McDonald's (MCD) and Chipotle (CNG)) so they spin it off in an effort to return this value to shareholders and raise additional cash. These spin offs are usually fast growers than then begin trading at relatively inflated pe values and their stock tend to outperform the market on a percentage basis until their growth slows as they mature. Here we have Altria (Phillip Morris), whose stock has performed better than any stock in the history of the market getting rid of an albatross.

The acquisition of Kraft was an ill conceived plan to diversify away from the business of tobacco. It accompanied the name change from Phillip Morris to Altria. Kraft does business in a low margin low growth arena and this never meshed with the highly profitable tobacco segment. This became a drag on the shares of Altria. Kraft's shares were hurt due to it's association with tobacco by both the stigma on it products and the potential for the tobacco litigation effects to spill over onto Kraft.

After the split Altria shareholders will get .7 Kraft shares for each Altria share they hold. In Kraft you will hold shares in a mature company that will begin a restructuring process (shedding brands) to return to more acceptable profit levels. Plus, very important here, Kraft has no durable competitive advantage (see earlier post). Brands can make for a durable advantage (Nike, McDonald's, Marlboro, Coke to name a few) but when you associate Mac & Cheese with tobacco, it disappears. You must be careful with your brand and nurture it, Kraft failed to do so. I am running from this stock. Who knows, it may end up turning thing around and be a success, but given the choice of owning MO or Kraft, to me it is a no-brainer.

In Altria you will have the best performing stock in the history of the stock market, paying a great dividend who is getting back to just doing what has made it great, selling cigarettes. Thanks to the Master Tobacco Settlement in 1998, the tobacco companies lawyers duped the states into essentially giving Altria a state sponsored monopoly (Marlboro has 50% market share). The states have become slaves to the tax revenues and "penalties" the tobacco companies who signed the settlement must pay (these have been easily passed on to smokers). It now behooves the states to protect the companies market share, sales and profits as their compensation is tied to these metrics. Should the companies lose ground (market share), they are entitled to refunds from the states. It is ironic, the states are trying to "stop smoking" but cannot live without the revenues those smokers provide via the tobacco companies. We are talking billions of dollars here, not millions. The tobacco companies in essence made the states defacto shareholders. Brilliant. Is it just me or did the tobacco industry's "legal environment" suddenly begin to change after this agreement was signed and the states realized that bad legal outcomes for the companies were in turn bad for them? Beginning in 2000 Big Tobacco began racking up one legal victory after another in the courts. It is to the point now where they are exposed to almost no credible legal challenges. To quote MO CEO Louis Camilleri yesterday "This is the best litigation environment ever for tobacco companies". Straight from the horses mouth. I am really not one prone to these conspiracy theories but sometimes "if it walks and quacks like a duck then....".

I would expect MO to spin off Phillip Morris International soon after the Kraft spin off is done at the end of March. Then I would look for huge dividend increases (maybe a special one time dividend) and massive share buyback to reward shareholders. To quote Sinatra "the best is yet to come...."

For those "morally opposed" to owning tobacco stocks. Don't be foolish. Why not own them, make gobs of money with them and do something good with it? Donate it to a charity, your church, pay off your kids school loans or even give it to "stop smoking" programs.

MO shareholders are going to make a lot of money for a long time, be one of them and do what you feel is the "most moral" thing with the proceeds. Maybe you can do more good in your corner of the world with it than they can do harm with their products. I am going to try....

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