Altria Group, Inc. (NYSE:MO) is one of the prominent players in the tobacco business. With renowned brands like Marlboro and a portfolio of other tobacco products, the company also expanded in other ventures but is now looking for exits and focus on the core business.
Yet, in the past 5 years, the debt-to-equity ratio ballooned up to a staggering amount. Running that much debt in a heavily regulated environment can pose a risk to any company.
Focusing on the Core Business
Recently, Altria Group announced a sale of the Ste. Michelle Wine Estates business to a private equity firm Sycamore Partners for US$1.2b. CEO Billy Gifford noted that this transaction would allow for a greater focus on cigarette alternatives for smokers - most notably, smokeless tobacco products.
Following a US$40m settlement between the Juul Labs and North Carolina, this removes just one of the pending legal actions as 13 other states filed lawsuits regarding the marketing practices that allegedly caused a rise in nicotine addiction among young people.
Altria Group invested US$12.8b in Juul Labs, but this investment is yet to live to its expectations. It doesn't surprise that the company has taken on considerable leverage to fund these investments.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing, as debt owners prioritize asset claims.
However, a more common (but still painful) scenario is raising new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an excellent tool for businesses that need capital to invest in growth at high rates of return. When considering how much debt a business uses, the first thing to do is to look at its cash and debt together.
What Is Altria Group's Net Debt?
As you can see below, Altria Group had US$29.7b of debt in March 2021, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$5.79b, its net debt is less, at about US$23.9b.
How Healthy Is Altria Group's Balance Sheet?
The latest balance sheet data shows that Altria Group had liabilities of US$10.0b due within a year, and liabilities of US$35.7b falling due after that.
Yet, it had cash of US$5.79b and US$142.0m worth of receivables due within a year. So its liabilities total US$39.8b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Altria Group has a huge market capitalization of US$87.4b, and so it could probably strengthen its balance sheet by raising capital if needed. Furthermore, a very high dividend yield of 7.3% could also come under pressure if debt becomes an issue.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
With a debt to EBITDA ratio of 2.0, Altria Group uses debt artfully but responsibly. And the alluring interest cover (EBIT of 9.1 times interest expense) certainly does not do anything to dispel this impression. Altria Group grew its EBIT by 3.1% in the last year. It isn't impressive, but it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Altria Group's ability to maintain a healthy balance sheet from now on. So if you're focused on the future, you can check out this free report showing analyst profit forecasts.
But our final consideration is also important because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Altria Group produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This means it can reduce its debt when it wants to.
Both Altria Group's ability to convert EBIT to free cash flow and its interest cover gave us comfort in handling its debt. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Altria Group is managing its debt quite well. The company has been taking advantage of low interest rates making its financing cheap and avoiding raising capital by diluting the shareholders.
But a word of caution: we think debt levels are high enough to justify ongoing monitoring.
There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Altria Group that you should be aware of before investing here.
When all is said and done, sometimes it's easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.