Why Altria trades at a 28% discount to Philip Morris

At ~$41 per share, Altria (NYSE:MO) trades at a P/E of ~10 and offers a yield of ~8.1%. At ~$72 per share, Philip Morris (NYSE:PM) trades at ~13.9 times earnings and offers a yield of 6.5%. Why is MO cheaper than PM?

One reason is MO’s bigger debt levels, such that its S&P credit rating is “BBB”, which is much worse than PM’s “A” rating.

Another reason is that investors are worried that a MO-PM merger would lead to essentially a dividend cut for current MO shareholders. PM currently offers a 6.5% yield that’s 20% lower than MO’s current yield.

Since the merger could be a potential all-stock, merger of equals, based on Tuesday’s market close prices, the combined market cap of Altria and Philip Morris would be ~$190.3 billion.

Additionally, based on the percentage of their current market caps the combined company’s annual payout would be ~$4.14 per share with a share price of ~$59.54 for the combined company. This implies a yield of ~6.95% for the combined company.

It’d appear current PM shareholders would get a 6.9% boost on their PM dividend income, while current MO shareholders would get a cut of ~14.5% on their MO dividend income.

Ultimately, the payout ratio of the combined company would be ~85.6% versus MO’s 2019 estimated payout ratio of ~80% and PM’s ~90%. So, if the merger materializes, there’s a possibility that a dividend cut could occur to make the payout ratio to be more conservative.

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Disclosure: As of writing, we’re long MO.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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