Wednesday, September 19, 2007

Altria: Now Farmers Will Help Shareholders

So much focus on the upcoming Altria (MO) spin (here included) has obscured a trend folks need to be aware of. Farmers are planting tobacco on almost 50% more acres than just 2 years ago.

The US Gov't ended it's tobacco subsidy system in 2004 that set price levels and dictate where and how much of the crop could be grown. As a result, there has been an explosion of planting of tobacco since then. Why? Profits. Let's compare tobacco to the other oft talked about crop, corn. Despite the higher labor cost involved with tobacco farming (it is harvested by hand), one can expect about $1800 profit per acre of tobacco, compared with $250 for corn even at the current high price of corn. Farms are sprouting in Illinois (from almost zero to 1,000 acres) and planted acres in Pennsylvania have doubled since 2004, not exactly the places one thinks of when they think of tobacco.

So why does this matter for Altria? Economics 100. The US supply of tobacco is exploding and shows no sign of slowing down. This will bring the cost of the product down dramatically and here is the best part (for investors), because it is still so profitable, the increase in acreage shows no sign of decrease. In fact, the majority of farms currently have plans underway to increase their current levels next year. Why? The previous subsidy system prohibited farmers from taking advantage of the price they could receive for the product by expanding production capabilities. Now, with tobacco selling for $1.60 a pound, it is still enormously profitable at almost 1/2 that. Tobacco is still the most profitable crop to grow and US acreage can double or even triple from current level without the danger of farmers abandoning it for other crops because despite smoking rates in the US going down, they are growing internationally and this enables any slack in the system to easily be exported. In fact US exports of the products have grown almost 50% since 2002.

This is really big news for shareholders. The price decrease in US tobacco costs for Altria should be more than offset by any decrease in use of their products for smoking. This of course does not take into account the expected results of their new smokeless products, just cigarettes.


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