The cannabis market is booming, with tremendous growth expected in the coming years. According to Canopy Growth Corporation (TSX: WEED, NYSE: CGC), the potential global opportunity is expected to exceed $200 billion by 2032. On the other hand, tobacco companies have been faced with a shrinking cigarette market. Altria, (NYSE:MO), in particular, has been most susceptible to this decline, given the fact that it operates in just the U.S. It is not an unknown fact that the smoking rate has been falling, with the U.S. witnessing one of the steepest declines in the world. In the face of this, a majority of the company’s revenue growth in the past has been a result of increasing the prices of tobacco products. However, given a higher volume decline than in the recent past, the smokeable segment, which forms a large chunk of the company’s sales, has been witnessing a fall in revenue. In the face of this, the fact that big tobacco companies may be looking into the cannabis space should not come as much of a surprise. According to The Globe And Mail, a deal between Altria and pot company Aphria (TSE: APH) may be in the cards, which we think may be a win-win for both.
We have a $71 price estimate for Altria, which is significantly higher than the current market price. The chart has been made using our new, interactive platform. You can click here for our interactive dashboard on Our Outlook For Altria In FY 2018 to modify the assumptions and gauge the impact on the company’s revenue, earnings, and price per share metrics.
Reasons Why A Deal Would Make Sense
1. Declining Tobacco Market: As mentioned earlier, Altria has been witnessing a falling cigarette market, with reported domestic cigarette shipment volume declining 7.6% in the first half of 2018. Consequently, the company has been focusing on its smokeless and innovative products segments to spur the growth. However, currently, these divisions form a very small chunk of their revenues, and although strong growth can be expected from these markets, it is nowhere near the enormous potential of the cannabis market.
2. Sufficient Cash Balance: Altria has a strong cash balance to pursue an investment in this space. As of June 2018, the company had cash and cash equivalents totaling $1.43 billion. Moreover, the company also generated free cash flows of $3.78 billion in the same time period, which could be used for an investment into a cannabis company, besides paying its dividend obligations.
3. Aid In Aphria’s Expansion: An investment by Altria will help the pot company to bolster its position in the cannabis space as it gives them the funds needed to strategically build or acquire key assets in the almost 30 countries pursuing a medical cannabis program. The money is also likely to be invested in the cannabis edibles space. The appeal of the edibles market is expected to increase at a fast pace once legalized in Canada (expected to happen next year), given its growth in the U.S. For example, in Colorado, the share of edibles and concentrates went up from 11% and 13% at the beginning of 2014 to 15% and 29% by the end of 2017. Furthermore, in California and Oregon, their combined share exceeds 35%.
4. Experience Of Dealing With Regulators: Altria has been operating in the highly controlled tobacco market for a while now, and hence, has sufficient knowledge of dealing with regulators. Moreover, its massive presence in the consumer goods industry will also help Aphria in better understanding customer trends and ensure better brand positioning. Altria will also be able to help the pot company with supply chain and distribution network planning.
Many skeptics have been citing the high valuations pot companies already sport as a reason why big tobacco may refrain from investing in this sector. However, given the fact that cannabis use is rising rapidly, while cigarette smoking is plunging, particularly in developed markets, tobacco companies don’t have much of choice than to ensure future growth is secured. Moreover, given the astronomical growth expected from this market, it may be better to be a first-mover, rather than playing catch-up in the years to come.