Research Proposal on "Altria and Apple Stock Analysis"

Research Proposal 12 pages (3411 words) Sources: 6 Style: MLA

[EXCERPT] . . . .

Altria & Apple

In this exercise, I selected two different stocks to purchase. One was Altria, the cigarette company and the other was Apple, the computer company. Each of these companies has distinctly different characteristics in terms of revenue stream stability, stock price volatility, sensitivity to economic conditions, dividend policy and other key variables. I felt that this contrast would make for an interesting study. Over the study period, both companies lost value, as did the market overall. One of the most interesting things to come out of this study, however, was that the results did not come in as expected. While the market brought both firms down, there were significant performance differences to do differences in firm-specific variables.

Altria

Altria (NYSE: MO), the former Phillip Morris is a holding company that includes cigarette maker Phillip Morris USA, cigar-maker John Middleton Inc., and 28.6% interest in global brewing giant SABMiller. This past spring, Altria spun off Phillip Morris International (NYSE: PM), which operates the Phillip Morris tobacco business outside of the United States. Phillip Morris USA has around a 50% share in the U.S. cigarette market, while SAB Miller is the nation's #2 brewer. These strong market positions have enabled the company to attain strong profitability over the past several decades, although both industries are currently beset with challenges ranging from global consolidation, increased regulation and taxation and declining sales.

On 10/28/08 I purchased 3500 shares of MO at $19.53. As of 12/5/08 these shares were worth $15.00. They have since rebounded slightly to $15.34. The cigarette industry is the key driver for the company and is considered to be non-cyclical. Demand is relatively price inelastic. Because the tobacco industry is heavily regulated, the key driver of the industry is government policy. This includes tax policy, advertising restrictions, sale restrictions and other barriers that are erected to curb tobacco use.

The non-cyclical nature of the industry is reflected in its low beta of 0.58. From October 28th to December 5th, the stock price declined $4.53, or 23.1%. Over the same period, the S&P 500 dropped from 940.51 to 876.07, a decline of 64.44. That equates to a percentage decline of 6.85%. This indicates that Altria stock declined more substantially over that period than did the overall market. The firm's beta, however, would have implied a decline of only 3.97%. Had this decline been experienced, the value of Altria stock on December 5th would have been $18.75. From this we can infer that the decline in Altria stock over this period was not simply a factor of the general market decline, but was a result of firm-specific considerations as well.

Indeed, the economic crisis is unlikely to have a significant impact on the operations of Altria. Demand in the tobacco sector is relatively price inelastic. Therefore, consumers who smoke do not view their habit as being optional. Thus, they do not reduce smoking significantly in the face of economic downturn. Thus, the state of the economy is not considered to be a major demand driver for Altria's main business. Indeed, this bears out in the performance of the Phillip Morris International stock, which Altria spun off to its shareholders. This unit represents the non-American Phillip Morris operations. Shares of PMI were $41.55 on the 28th of October and $42.36 on the 5th of December.

The performance of the Altria Group, therefore, can be attributed to non-economic domestic factors. Indeed, the threat of a federal excise tax hike in 2009 is considered to be one of the reasons for the stock's underperformance in recent weeks. This hike is expected to be in the range of 61 cents, which reduces Phillip Morris USA's ability to raise prices to cover increases in its costs. The company is also facing an environment where they must increase advertising spending in order to staunch market share erosions in their premium brands, which has also hurt their potential profitability (Reuters, 2008).

Other factors unrelated to the economic downturn also affected the stock price of Altria. The InBev purchase of Anheuser-Busch closed in November, allowing the Belgian brewing conglomerate to overtake SABMiller as the world's leading brewer. This places increased competitive pressure on SABMiller, which threatens to reduce that firm's profitability and market share worldwide. Another factor was the announcement of new product developments by rival tobacco firm RJ Reynolds. In an intensely competitive, contracting market, such developments are seen as a threat to Phillip Morris' market share.

The tobacco industry overall is relatively unaffected by the current economic crisis. Some individuals may decrease consumption due to poverty or as a means to reduce expenditures but overall this is unlikely to be a significant demand driver for the tobacco industry. The economic slump, however, may have some indirect consequences for the industry. One is that the government is spending billions of dollars on bailouts for struggling sectors, and is slated to spend billions more in economic stimulus programs. However, government tax revenues will inevitably decline as a result of the decline in economic activity. This has resulted in an increased probability of an excise tax hike next year, as government moves to alleviate some of the funding shortfall by adding to sin taxes.

The trickle down impact on Phillip Morris USA is expected to be a direct reflection of the impacts on the industry as a whole. The tobacco industry in the United States is characterized by near-oligopolistic conditions and heavy regulation. Therefore, there is little basis on which to separate the firms that operate within the industry. Phillip Morris has adopted neither a differentiated strategy nor a cost leadership strategy. As a result, they have developed no insulation against industry-wide impacts. Whatever happens to the cigarette business as a whole happens to Phillip Morris USA.

Altria's only insulation comes from its other two holdings, the John Middleton cigar business and the stake in SABMiller. The cigar business is closely related to the cigarette business, especially the machine-manufactured cigar segment in which John Middleton operates. Thus, the drivers for that segment are very similar to those affecting the cigarette industry.

If anything, John Middleton is more susceptible to economic downturns as consumers trade down to ordinary cigarettes. The SABMiller stake is also more susceptible to economic downturn than the cigarette business. Demand for beer is more price elastic than for cigarettes. However, SABMiller can gain from their low-end position as consumers trade down from imports, making up for sales losses due to economic slowdown. Moreover, SABMiller derives a significant portion of its revenues overseas, much of it in countries that have yet to be severely affected by the global slowdown. Therefore, Altria is fairly well-insulated from the impacts of global slowdown and the impacts such a slowdown might have on the industries in which it operates. It is, however, strongly subject to the impacts of shifts in the legal and regulatory environment of the tobacco industry.

Employment, production and income are all linked. Employment is one of the components of production output, along with productivity. As employment increases, all else being equal, so will production output. Increases in production out, again all else being equal, will increase income. Increases in income allow firms to expand, thus increasing employment and production. This is the basic cycle of economic growth. Over the past few months, employment in the U.S. has decreased, as has production. This compromises the nation's income. Such declines do not affect Altria as much as they do other firms.

Cigarette consumption, for example, declines less when national income declines than does consumption for many other consumer goods. Beer is generally affected, but less so at the low end because consumers trade down to products such as those produced by SABMiller. This also holds true for the cigar market and John Middleton's machine-made cigars. Thus, shifts in these three key economic variables have only limited impact on Altria, which is why their beta is so low.

Since the economy is not the reason the stock declined as much as it did over the past several weeks, we must look to other drivers to evaluate why an investor would be interested in this security. The company operates in two heavily-regulated, declining businesses. These industries are highly competitive and the dominant companies are steadily losing revenues. The result is intense rivalry that squeezes margins.

One of the main benefits of owning a company like Altria is the theoretically steadiness of its income streams. The inelasticity of demand is a major factor in those theoretically steady revenue streams. The result is a low beta, meaning that by adding Phillip Morris to an investor's portfolio will reduce the portfolio's overall risk. However, the inelasticity of demand also creates problems for tobacco companies. Governments use excise and other taxes on tobacco products to generate revenues. This limits the capacity of tobacco companies to raise prices in response to increases in the cost of their inputs. As a result, margins are squeezed. In an industry where the main competitors are already losing customers due to… READ MORE

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