It seems impossible to mention the words ‘blue chip’, without also mentioning Altria Group (MO). It has a strong business model, and pays one of the most rock-solid dividends in the entire stock market.

Technically, Altria is not a Dividend Aristocrat. The Aristocrats are a group of 51 stocks in the S&P 500 Index, with 25+ years of consecutive dividend increases. You can see all 51 Dividend Aristocrats here. But this is only because Altria’s various spin-offs over the years have masked its dividend history. Instead, Altria is a Dividend Achiever, which have raised dividends for 10+ years in a row. You can see all 265 Dividend Achievers here.

Altria has increased its dividend 50 times in the past 48 years. Today, it has a 3.4% dividend yield. These qualities make it a blue chip, which we define as companies with 100+ years of dividend payments, and at least a 3% yield. You can see the full list of blue chip stocks here. Altria’s valuation has expanded considerably over the past several years, but it remains a solid blue-chip holding.

Business Overview

Altria is the largest U.S. tobacco company. It manufactures a variety of products, including cigarettes, cigars, and smokeless tobacco products. It also has a wine business, under the Ste. Michelle Wine Estates brand.

The flagship of Altria’s fleet continues to be Marlboro, which dominates the cigarette industry. Marlboro now commands nearly half of U.S. retail share.

Source: 2017 CAGNY Presentation, page 42

In addition, Altria has exposure to the beer industry. It held a 27% ownership stake in global beer giant SABMiller. After SABMiller was acquired by Anheuser Busch Inbev (BUD), Altria now has a 10.2% stake in AB Inbev.

Altria incurred a massive $13.9 billion one-time gain from the SABMiller acquisition last year, which caused GAAP earnings to skyrocket. Reported earnings-per-share soared 173% for 2016, to $7.28. Adjusting for this gain, operating earnings-per-share increased 8.2%, to $3.03. This is obviously a much lower growth rate, but still represents healthy earnings growth from the core business.

Altria has diversified portfolio, as it has taken steps in recent years to expand beyond cigarette. Still, the vast majority (approximately 86%) of Altria’s operating revenue and earnings are derived from smokeable products. This presents a challenge for Altria. Smoking rates continue to decline, particularly among young consumers. The task for Altria is to continue growing profit, even though revenue may decline over the long term. Fortunately, the plan is in place, and working well.

Growth Prospects

Altria has a three-pronged strategy for generating long-term earnings growth:

• Revenue growth from new products
• Cost cuts
• Share repurchases

The first growth catalyst for Altria is new products. In an environment of declining cigarette shipments, innovation is key.

The good news is, Altria is investing heavily in next-generation products, such as e-vapor and heated tobacco. Altria’s MarkTen XL is rapidly gaining market share.

Source: 2017 CAGNY Presentation, page 74

Altria’s NuMark subsidiary has now rolled out MarkTen e-cigarettes to stores representing more than half of the U.S. e-vapor retail category.

In April, Nu Mark expanded MarkTen to approximately 10,000 more stores in the U.S. Separately, Altria is also developing heated tobacco products, under the iQOS product line. Altria sees the iQOS line as its best attempt to counter declining smoking rates.

The company calls heated tobacco a ‘reduced-risk’ product, because the perceived detrimental health effects are improved, relative to traditional cigarettes. Altria has submitted both product applications for iQOS to the FDA. The company hopes commercialization for iQOS is approved by the end of the year. Next, Altria aims to expand profit margins, and has been highly successful there as well.

Source: 2017 CAGNY Presentation, page 41

Operating profit margin in the core smokeable products segment expanded by six percentage points, from 2013-2016. The company plans further cost reductions, including a $300 million productivity initiative. Cost savings will be realized through multiple levels of the organization.

Altria also heavily repurchases shares, to help drive earnings growth. Last year, Altria repurchased $1 billion of shares. Since the beginning of 2011, it has utilized $5.6 billion for buybacks.

The company expects adjusted earnings-per-share growth of 7.5%-9.5% in 2017. Such steady earnings growth, even in a difficult operating climate, is due to Altria’s competitive advantages.

Competitive Advantages & Recession Performance

Altria’s two competitive advantages are industry economics, and brand strength. Manufacturing tobacco products is an extremely lucrative business, because it is not capital intensive.

For example, Altria generated $3.2 billion of operating cash flow in 2016. This is cash flow derived from the core business activities.

At the same time, capital expenditures last year were just $189 million. This means free cash flow exceeded $3 billion, which allows the company to invest in future growth, buy back stock, and pay dividends. In addition, Altria enjoys tremendous pricing power. The company sells an addictive product, one that is not at risk of being under-cut by a competitor. This gives it a great deal of brand equity. According to Forbes’ 2017 rankings, Marlboro is the No. 25 most valuable brand in the world.

Altria’s competitive advantages make it a very recession-resistant business. Its financial performance during the Great Recession is as follows:

• 2008 earnings-per-share of $1.66
• 2009 earnings-per-share of $1.76
• 2010 earnings-per-share of $1.87

Altria remained highly profitable and continued to grow, even during the Great Recession.

Valuation & Expected Total Returns

Valuation is a key consideration for investors. Buying a high-quality company is usually a rewarding decision over time, but not always, if the investor pays too high a price for future earnings.

In Altria’s case, the stock is far more expensive than it seems. Scrolling through most financial website will reveal that Altria has a price-to-earnings ratio of 9.8, which would appear to indicate a cheap stock. For comparison, the S&P 500 Index has an average price-to-earnings ratio of 24.7 right now. But remember, Altria’s huge one-time gain from the SABMiller acquisition inflated its earnings.

Investors should value the company based on its adjusted earnings-per-share since this figure represents the earnings power of the business. On the basis of 2016 adjusted earnings-per-share, Altria trades for a price-to-earnings ratio of 23.8, a slight discount to the S&P 500.

Altria does not appear to be overvalued, but excluding the one-time gain causes its price-to-earnings ratio to more than double.

Altria’s price-to-earnings ratio has expanded significantly over the past several years, which is likely to slow going forward. The good news is, returns will still be generated by earnings growth and dividends.

A reasonable breakdown of Altria’s future returns is as follows:

• 6%-8% earnings growth
• 3.4% dividend yield

Earnings growth will be comprised of revenue growth, margin expansion, and share repurchases. As a result, Altria could generate total returns of approximately 9%-12% per year.

Final Thoughts

Conditions are difficult for Altria right now, as smoking rates are on the decline. But Altria has successfully navigated challenging times before, and will likely do so again.

Investors have reaped huge returns from Altria over the past several years. Since these gains have been fueled in large part by an expanding price-to-earnings multiple, investors should not expect to see the same kind of returns moving forward.

Still, there is no reason why Altria can’t generate high single-digit to low double-digit annualized returns.

Altria is a blue chip, if there ever was one.