No industry has cash flow like the tobacco industry. Making cigarettes costs very little compared to what the consumer pays. With a few plant upgrades, there is not much capital expense. Many tobacco firms have operating margins of 20%.
That made it all the more shocking that Altria Group (NYSE: MO) said it would delay buying UST Inc. (NYSE: UST) because of concerns about the credit market. Altria is considered one of the most stable large companies in the U.S. According to The Wall Street Journal (subscription required), "While attention has been focused on problems in the market for short-term loans or lending between banks, the Altria situation shows that even highly rated companies borrowing money for standard purposes such as acquisitions are having trouble getting funding."
The transaction for UST was valued at just over $10 billion, but the company had $2 billion in revenue and almost $900 million in operating income last year. The firm only has $1 billion in long-term debt.
If the Altria buyout can be scuttled by the credit crisis, any deal can be. More pending M&A transactions may be delayed or killed, even if both companies in a marriage are healthy.
Things has gotten that bad.
Douglas A. McIntyre is an editor at 247wallst.com.
The Wall Street Journalreports (subscription required) that Altria Group Inc. (NYSE: MO) has agreed to acquire UST Inc. (NYSE: UST) for $10.3 billion in cash. According to the Journal, "The deal would give Altria a strong foothold in smokeless tobacco, a growing area of the market where it has had difficulty making inroads against long-established brands."
The deal diversifies Phillip Morris away from cigarettes -- a business that's declining by 3% or 4% -- and into the smokeless tobacco business that's increasing in the 6-7% range.
What is interesting about this deal is that it also acquires more of the potentially-disastrous legal liabilities that come with selling and aggressively marketing a product that causes people to die a slow and painful death -- Altria is apparently betting that the legal liabilities are already priced into UST stock. If they're right about that, it bodes well for the tobacco industry as a whole.
UST owns the Skoal, Copenhagen, Red Seal, and Husky smokeless tobacco brands, and also has interests in alcohol through its Ste. Michelle Wine Estates business.
"With $37.2 billion in revenues in 2007, Kraft Foods (NYSE: KFT) is the largest food manufacturer in the U.S. and second-largest worldwide," notes leading turnaround stock expert George Putnam.
The editor of The Turnaround Letter explains, "New management has begun to shake things up and the turnaround program is well underway." Here's the advisor's review.
"The roots of some of Kraft's products reach all the way back to 1767, but it wasn't until 1903 that James L. Kraft started his wholesale cheese business from a horse drawn wagon in Chicago. Today, Kraft produces many of the best-known food brands in the world.
"In 1988, Philip Morris (renamed Altria) purchased Kraft, and in 2000 it integrated the purchase of Nabisco into Kraft. Altria sold a small stake to the public in 2001, but maintained majority control until 2007, when the company was completely spun off as an independent company once again.
"Under the Altria umbrella, Kraft stagnated, with declining revenues and little product innovation. As a result, the stock price today is within $1 of the price where it was when first sold to the public in mid-2001.
"New management has begun to shake things up at Kraft. In June 2006, veteran food executive Irene Rosenfeld became CEO, returning to Kraft from a stint at Pepsico running its Frito-Lay division.
The history of General Foods can be traced back to the Postum Cereal Company, founded by Charles William Post, inventor of Postum and Grape Nuts, in 1895. Wall Street player E.F. Hutton in time became the chairman, and he initiated a series of acquisitions beginning in 1925: Jell-O, Minute Tapioca, Log Cabin, Hellmann, Calumet Baking Powder, and Birdseye. It was after the Birdseye acquisition in 1929 that the food conglomerate became General Foods.
Among General Foods' many product offerings were Sanka decaffinated coffee and the astronaut's favorite, Tang. General Foods also continued to make acquisitions, including the makers of Kool-Aid in 1953, the Burger Chef restaurant chain in 1968, and Oscar Mayer in 1981.
But late in 1985, General Foods was itself acquired by Philip Morris Cos., which later became Altria Group (NYSE: MO), in the largest non-oil acquisition to date. When Philip Morris acquired Kraft in 1988, the two food companies were merged. In 2007, Altria spun off Kraft Foods (NYSE: KFT), which now owns such former General Foods brands as Jell-O, Kool-Aid, and Maxwell House coffee. And it was announced in late 2007 that Post Cereals, including Grape Nuts, would be sold to Ralcorp Holdings (NYSE: RAH).
Altria (NYSE: MO) shares are trading higher today, getting a boost from news that menthol is getting special protection in a new bill as Congress attempts to regulate the tobacco industry. Menthol brands, which make up about one-fourth of the US tobacco output, is getting an exemption from a ban on cigarette flavoring like cinnamon and clove. If you think that the stock won't fall by too much in the coming months, then now could be a good time to look at a bullish hedged trade on MO.
After hitting a one-year high of $79.59 in January, the stock spun-off Phillip Morris International (NYSE: PM) in March and hit a one-year low of $19.95 early this month. MO opened this morning at $21.57. So far today the stock has hit a low of $21.50 and a high of $21.94. As of 1:00, MO is trading at $21.85, up $0.27 (1.2%). The chart for MO looks bearish and steady, while S&P gives the stock its highest 4 Stars (out of 5) strong buy rating.
For a bullish hedged play on this stock, I would consider a September bull-put credit spread below the $20 range. A bull-put credit spread is an options position that combines the purchase and sale of put options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. For this particular trade, we will make a 19.0% return in just four and a half months as long as MO is above $20 at September expiration. Altria would have to fall by more than 20% before we would start to lose money. Learn more about this type of trade here.
Altria Group (NYSE: MO) shares are trading higher after the company announced it is cutting promotional discounts and raising prices on cigarette brands starting today. This move was made to stem losses from lower cigarette volumes. If you think that the stock won't fall by too much in the coming months, then now could be a good time to look at a bullish hedged trade on MO.
After hitting a one-year low of $19.47 in July, the stock hit a one-year high of $24.55 in January. MO opened this morning at $20.75. So far today the stock has hit a low of $20.50 and a high of $20.86. As of 12:40, MO is trading at $20.79, up $0.36 (1.7%). The chart for MO looks bearish but improving, while S&P gives the stock its highest 5 STARS (out of 5) strong buy rating.
For a bullish hedged play on this stock, I would consider a September bull-put credit spread below the $19 range. A bull-put credit spread is an options position that combines the purchase and sale of put options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. For this particular trade, we will make a 26% return in just four and a half months as long as MO is above $19 at September expiration. Altria would have to fall by more than 8% before we would start to lose money.
MO hasn't been below $19 at all in the past year and has shown support around $20 recently. This trade could be risky if investors rotate out of historically defensive stocks, but even if that happens, this position could be protected by the support the stock might find around $20, where it bottomed out both this past week and back last fall. Brent Archer is an options analyst and writer at Investors Observer. At publication time, Brent neither controls bullish hedged positions in MO.
I've received a few chuckles for investment directions I've suggested in the past, but if you care to review a couple of my previous generalities, I believe that my record has held up fairly well.
I submit for approval the following investment angles for the balance of 2008 and possibly beyond:
Have I suggested investments in water holdings? Yes, I do believe that I have. I believe that going long in water stocks could be an investment hedge of the decade. I also suggest a look into the desalination technology from General Electric Co. (NYSE: GE).
I'd think it's a good idea to stick with the railroads, such as Burlington Northern Santa Fe (NYSE: BNI). I claim that, with all things given, for now, railroads can't fail. Conversely, I think it's a good time to back away slowly from trucking. I think misery lies ahead there.
MOST NOTEWORTHY: AU Optronics, General Steel and Sequenom were today's noteworthy initiations:
Jefferies initiated AU Optronics (NYSE: AUO) with a Buy rating and $25 target and believes LCD trends will be healthy in 2008 despite a soft economy.
General Steel (NYSE: GSI) shares were started at Merriman with a Buy rating, as the firm believes strong demand for steel in China should last for years and finds the valuation attractive at current levels.
Cantor believes Sequenom (NASDAQ: SQNM) is positioned to establish sustainable market leadership as a provider of genome analytical products and molecular diagnostics. Shares were assumed with a Buy rating and $12 target.
OTHER INITIATIONS:
UBS initiated Altria Group (NYSE: MO) with a Buy rating and $30 target.
Canaccord Adams assumed Drugstore.com (NASDAQ: DSCM) with a Buy rating and $3.50 target.
Goldman Sachs initiated DirecTV (NASDAQ: DTV) with a Buy rating and $30 target.
"Altria (NYSE: MO) is one of the best stocks to own in this current market environment," says leading market expert Bill Martin. In his Bullmarket.com, he looks at the stock's defensive characteristics.
"Altria just recently reiterated its earnings outlook for itself and soon to be spun-off Philip Morris International (PMI). Excluding PMI, Altria said it expects to grow 2008 EPS by 9-11% off an adjusted base of $1.50. Longer term, the company expects EPS growth of 8-10%.
"Altria's projections come despite the company expecting cigarette volumes in the U.S. to decline by -2.5% to -3.0% over the next few years. The company also anticipates cost savings of $1 billion annually as a result of the PMI spin-off, with $300 million realized last year and the rest to be wrung out by 2011.
"PMI, meanwhile, is forecasting 12-14% EPS growth from a 2007 pro-forma adjusted base of $2.78. Longer term, the company is looking for EPS growth of 10-12% on revenue growth, net of excise taxes, of 4-6%.
"Shipment volume is projected to rise 1-2%, helped by the introduction of new products. The company also expects to realize $1.0 billion in annual cost saving by the end of 2010, and a cumulative total cash flow of approximately $22 billion by the same date.
"Altria continues to be a solid defensive holding paying an attractive dividend -- both of which are invaluable attributes in this market. With the PMI spin-off on track and large buybacks set to be implemented after the split, Altria is one of the best stocks to own in this environment. We rate the stock a buy."
Each day, Steven Halpern's TheStockAdvisors.com offers the latest market commentary and favorite investment ideas from the nation's leading financial newsletter advisors.
MOST NOTEWORTHY: Amazon.com, Altria Group and Skilled Healthcare were today's noteworthy initiations:
Canaccord Adams expects Amazon.com (NASDAQ: AMZN) growth to be driven by its expanding international reach, mix shift to third-party revenue, product innovation, and category expansion. The firm initiated shares with a Buy rating and $78 target.
UBS is positive on Altria's (NYSE: MO) growth, low likelihood of downward EPS revisions, and best-in-class cash flow distribution; shares were started with a Buy rating.
Skilled Healthcare (NYSE: SKH) was initiated with an Outperform rating at Morgan Keegan, as they believe nursing home reimbursement risk is already reflected in its valuation.
OTHER INITIATIONS:
KeyBank assumed Callaway Golf (NYSE: ELY) with a Buy rating and $19 target.
Credit Suisse initiated Intuit (NASDAQ: INTU) with an Outperform rating and $35 target.
Broadpoint initiated Novell (NASDAQ: NOVL) with a Buy rating.
Wall Street has speculated for some time that Altria's (NYSE: MO) international units will be spun-off from its domestic tobacco operations. The company's board believes that this will allow overseas operations to work without the baggage of regulations and lawsuits that the firm faces in the US.
According toThe Wall Street Journal, "the separate entity, for example, would be exempt from US tobacco regulations and out of reach of American litigators. Importantly, its practices would no longer be constrained by American public opinion, paving the way for broad product experimentation." Put another way, the international operations will be able to make stronger, and perhaps more dangerous tobacco products, for large markets in Europe and Asia.
China will be a major target for the new public company to be called PMI. Other large markets the company will focus on include Indonesia and Pakistan.
The Altria international operations are about four times as large as those in the US. That alone may make the case for the company to be independent.
But, at the end of the day, the name of the game is selling much stronger cigarettes to people who want them in markets where regulation is lax. A good way to make money, but bad for the lungs.
Douglas A. McIntyre is an editor at 247wallst.com.
No industry has cash flow like the tobacco industry. Making cigarettes costs very little compared to what the consumer pays. With a few plant upgrades, there is not much capital expense. Many tobacco firms have operating margins of 20%.
The Wall Street Journal 
Here are some highlights from this past week's 
This post is part of a series on some of the most memorable 
I've received a few chuckles for investment directions I've suggested in the past, but if you care to review a couple of my previous generalities, 
Philip Morris
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The Wal-Mart Weekly: Retailer accused of sweatshop conditions in Bangladesh
Fog clearing - maybe. Clear skies - no! GE, JNJ, MRK, PG, RTN, WFC
Cramer on BloggingStocks: A fighting chance for the credit markets.
