Thursday, August 30, 2007

Altria (NYSE:MO): Deutsche expects upside in MO

- Deutsche Bank is positive on Altria (NYSE:MO) today raising their tgt to $82 from $80 after the co said yesterday it will spin-off Philipp Morris Intl tobacco unit. DB thinks the spin will be an early 2008 event, just like Kraft this year. The relevant question now is where do we go from here? The balance sheet opportunity is vast. For example, $30 billion in leverage puts PM USA at 1.8 times debt/EBITDA, (a de-facto A-industrial level even if the agencies don't think so owing to legal risks) and PMI at 2 times. A 75% dividend pay-out on Philip Morris USA (PM USA) earnings would drive a yield of 5.4% if it traded at 14x P/E on 2008 forecasts. PMI would trade on a yield of 4.6%.

But there's another wrinkle to start thinking about now as well - cost savings via business restructure and/or acquisitions. The simple math today is every 1% in EBIT margin drives $150 million in profits at PM USA and $230 million at PMI. So as stand alone companies, maybe they belt tighten 3% points in margin each. That's $450 million at PM USA and $690 million in PMI. Using the sum of parts metrics multiples applied below, such an outcome drives another $5-6 in share value or valuation in the high $80's. Based on these factors, they are surprised that the share price reaction has not been stronger

Altria remains Deutsche's best large cap idea with revised target price implying 22% total return upside in the shares over the next 12 months. Maintains Buy.

Notablecalls: When was the last time you saw a 22% total return upside in MO? Deutsche's no foolish operator but their tgt is still way below say for example Morgan Stanley's $87 number (reited Overweight yesterday).

I strongly feel that based on yesterday's news, MO stock deserves to be at least 2-3 bucks higher than the current quote. I expect this to happen over the next week or so. I'm as surprised as Deutsche by the lack of share price reaction yesterday.

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