2 Defensive “Vice” Stocks To Buy: Altria Group And Diageo PLC

For those who are comfortable investing in “vice” stocks, growth and income expert Rida Morwa, editor of High Dividend Opportunities and a contributor to MoneyShow.com, looks at two “battle-tested, inflation beating” investments — a tobacco firm and a liquor company.

These companies are time-tested and have grown sales and raised dividends paid to shareholders through good and bad economic conditions. With a combined yield of ~4.6% and a combined compound annual dividend growth rate of over 6% in the past five years, these picks are well-positioned to fight rising rates.

Altria Group (MO) needs no introduction. The company is one of the world’s largest producers and marketers of tobacco, cigarettes, and related products. Irrespective of economic conditions, wars, recessions, and natural disasters, the demand for these products has remained robust.

The number of smokers in the U.S. continues to decline, and so does the volume of combustible tobacco products. Yet, Altria managed to grow its full-year 2021 revenue (net of excise tax) and adjusted EPS by 1.3% and 5.7%, respectively. The company has tremendous pricing power due to its highly loyal customer base and strong brands like Marlboro.

Last year, Altria Group and Philip Morris USA announced a 15-cent-per-pack cigarette list price increase for some leading brands. Due to their ability to pass on inflation costs to customers, Big Tobacco is undoubtedly one of the more dependable sectors for income investors, for reliable and growing dividends.

As cash flow from the smokable tobacco business remains steady, Altria can grow its new product segments that are growing in popularity among the younger population and starting to experience regulatory tailwinds.

Altria’s vape line (IQOS and Marlboro Heatsticks) faces regulatory headwinds due to the infringement of Reynolds America’s (BTI) patents and the ITC ruling towards an importation ban and cease-and-desist orders. While vape products are instrumental in Altria’s shift away from traditional cigarettes, the segment accounts for a tiny percentage of total sales today.

The company has a 10% equity stake in Anheuser-Busch InBev (BUD), a 35% stake in e-cigarette maker JUUL, and a 45% stake in the cannabis company Cronos Group (CRON) as effective diversification from combustible products.

Altria is among 35 Dividend Kings in the market today, with 56 quarterly dividend increases in the past 52 years. The company’s current $3.60/share represents a generous annual yield of 7.1%. Its most recent dividend payment was at a payout ratio of 73%, well below the company’s 80% target.

The shareholder value creation doesn’t stop there. Altria is significantly undervalued at 9.8x. Management realizes the undervaluation, and the company has been pursuing its sizable $3.5 billion share repurchase program. At the end of 2021, the company purchased almost 51.2 million shares and has $1.8 billion remaining under the program.

Altria is a stock that you hate to love. Cigarettes aren’t glamorous, but they sell in large volumes despite the status of the economy, and consumers are ready to pay higher prices for them. Its core business remains steady as they pursue diversification into more attractive opportunities. The handsome 7.1% yield is an excellent incentive to stay invested for future growth prospects of this Dividend King.

Our next “vice” pick comes from another formidable industry — beverage alcohol. This is an excellent industry for income investors as history tells us that alcohol sales remain stable even when consumer spending is choppy elsewhere. What makes things more exciting and attractive is that alcohol sales have increased during economic crises, including the Covid pandemic.

Diageo PLC (DEO) is a global leader in this sector, has a colorful portfolio of over 200 brands, and operates in over 180 countries. Despite COVID-19 variants and associated global restrictions on restaurants and bars, the company reported its stellar 1H 2022 performance, with net sales of £8.0 billion (15.8% growth YoY).

Compared with other beverage alcohol companies, Diageo’s geographic diversification ensures stability from the mature and highly profitable North American market and growth from the highly populated Asia-Pacific market.

In addition, Diageo’s product diversification mitigates any short-term impact from taste changes and preferences, the most notable one being drinkers switching to spirits from beer for health reasons in crucial markets.

Diageo’s big push into more expensive brands provides them a comfortable advantage in these inflationary times. Premium plus brands contributed 56% of reported net sales, up from 34% in 2015. Because wealthier drinkers are less sensitive to price increases, Diageo expects to grow its margins in FY22 despite higher commodities, shipping, and packaging costs.

Diageo pays dividends semi-annually, an interim dividend in April and a final dividend in October. The approximate split between the two payments is 40/60. During 1H 2022, the company raised its interim dividend by 5%.

Although we expect the final dividend to also be raised in 2H 2022, Diageo yields ~2% annualized by factoring in just the interim raise. (Please that Diageo pays the dividend in British Pounds.) and the payout amount can vary with the US dollar-British Pound rate.)

Diageo is a European Dividend Aristocrat and has set itself up for the 25th consecutive year of dividend growth with its recent raise. In the past five years, the company has had a 4.2% CAGR dividend growth and maintains an impressively high dividend-to-EPS coverage. Interim dividend (29.36p) was covered by its half-yearly basic EPS (84.3p) 2.9 times!

The company ended 2021 with an A- rated balance sheet, with a leverage of 2.5x. This strong balance sheet enables the company to continue acquiring leading brands to fortify its brand portfolio. Diageo continues to add value to shareholders with its £4.5 billion buyback program.

The company completed £0.5 billion of share buybacks in 1H22 and intends to complete the buyback by the end of FY23. Diageo is a leader in beverage alcohol and consistently maintains higher EBITDA margins than the competition.

Beverage alcohol is an excellent cash-producing business during economic uncertainty, and Diageo is a fundamentally sound leader in the sector. This dividend-growth stock provides a comfortable hedge against inflation and should be part of an income portfolio.

When volatility is high, stocks go up and down, often creating a lot of fear, uncertainty, and doubt (‘FUD’). The key is to maintain a steadily growing income stream through all the noise. When your income remains intact, you can ignore the FUD and buy more of your quality picks.

Our core focus is finding opportunities that generate recurring paychecks in the form of dividends and distributions. We actively select dividend-paying companies run by shareholder-friendly management teams to work past near-term macroeconomic headwinds that our economy faces.

The strategy works because not only do you get more bang for your buck with high yields, but you also have a portfolio that is relatively insensitive to changing interest rates. Combine that with the ability to pass inflation costs to the customer, and you have a winner.

Altria and Diageo have a combined yield of 4.6%, and a 6% combined CAGR dividend growth rate. They are a Dividend King and Aristocrat respectively in robust sectors with heavy brand loyalty. This gives these companies tremendous pricing power that positions them well to come out of these inflationary times and rate hikes with flying colors.

(Disclosure: Rida Morwa and/or associates of High Dividend Opportunities have a beneficial long position in the shares of MO AND DEO either through stock ownership, options, or other derivatives.)

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