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Investment Overview for Altria Group, Inc. (NYSE:MO)
WHAT HAS CHANGED?
- Changes in trends and Altria's performance
- Altria announced its second quarter results on July 27th, beating EPS expectations, but missing out on revenue. While adjusted EPS grew 9.5% over the second quarter of the previous year, the revenues remained largely flat at $4.88 billion. The decline of 5.5% in the shipment volume of the company's main brand, Marlboro, reflecting the decline in the industry and trade inventory movements, coupled with a 0.1 percentage point decline in its market share, were a drag on the revenue. The overall market share of the company remained flat, with growth in the share of its discount brands. Higher cigarette prices and cost cuts implemented by the company helped to bolster the earnings.
- Other factors to watch out for
- In May 2015, the much talked about merger between industry No.2 and No.3, Reynolds American and Lorillard, was given FTC clearance. Apart from forming a more competitive force against Altria, this combination could give Altria's menthol offerings tough competition, with leading brands such as Newport and Camel in their portfolio.
- Apart from this, there is the proposed merger between mega brewers AB InBev and SABMiller. Altria has an ~27% stake in SABMiller, and hence, this merger coming through could have varied implications for Altria's financial standing. AB InBev is in the process of shedding its assets to gain regulatory approval for the deal. In Q3, Altria's management addressed the merger, calling it a "compelling opportunity" and further saying that Altria would continue to "manage that asset for the best interest of Altria's shareholders." During the Q2 2016 earnings call, Altria also raised its outlook for the year, saying it expects adjusted earnings of $3.01 to $3.07, up from $3 to $3.05 per share. However, the company stated that the figure does not account for the impact of the proposed merger.
Altria's Retail Share in Cigarettes: We currently estimate Altria's market share in cigarettes to reach 51.7% by the end of the Trefis forecast period. If however, Altria manages to increase its market share to 56% by 2021 through effective marketing of its new Marlboro premium brand architecture, and consistently increase volumes of its discount brand sales, it would imply a 5% upside to the Trefis price estimate.
Revenue per Smokable Product: We currently estimate revenue per smokable product unit to increase by ~17% over the course of the Trefis forecast period, which would suffice to offset the current cigarettes industry volume decline. However, it is also possible that the annual increase in revenue per cigarette is lower than expected due to lower room for higher pricing. A 1% annual rate of increase would imply a 10% downside to the Trefis price estimate.
Altria Group, Inc. (previously named Philip Morris Companies Inc.) is one the largest tobacco corporations in the world and the parent company of Philip Morris USA, John Middleton Inc., United States Smokeless Tobacco Inc., Philip Morris Capital Corporation, and Chateau Ste. Michelle Wine Estates. The company formerly owned Kraft Foods (KFT) and Philip Morris International (PM), which housed its international tobacco business. In January 2009, Altria Group completed the acquisition of UST Inc., a moist smokeless tobacco manufacturer and owner of the Chateau Ste. Michelle Wine Estates. In addition, Altria has a 27.1% interest in UK based SABMiller, one of the world's largest brewing companies.
The brand portfolios of Altria’s tobacco operating companies include well known names such as Marlboro, Copenhagen, Skoal, and Black & Mild. Ste. Michelle produces and markets premium wines sold under various labels, including Chateau Ste. Michelle and Columbia Crest. It exclusively distributes and markets Antinori, Champagne Nicolas Feuillatte, and Villa Maria Estate products in the United States.
Cigarettes and cigars are the most valuable division with about 67% contribution to Altria's value
Cigarettes and cigars are the most valuable division of Altria Group with about 67% contribution to its stock value. Philip Morris USA occupies more than 50% retail share in the US cigarettes market. It sold more than 127 billion cigarettes and cigars in 2015, with Marlboro being the most popular cigarette brand occupying a giant retail share of 44% by itself. This increased by 0.2 share point in 2015, and the number of cigarettes sold by Philip Morris USA increased to 126 billion.
Growth in smokeless tobacco products
Smokeless products is a high growth niche segment of tobacco products in the US and is projected to grow at an annual rate of around 3% over the next few years. Altria currently occupies more than 55% of the market share in the US in terms of volume of sales with its leading smokeless tobacco brands which include Copenhagen, and Skoal.
Declining tobacco consumption
Volume of tobacco products sales have been declining as a result of growing health consciousness amongst people about the extreme health risks of smoking. Federal and state governments in the U.S. have also been discouraging tobacco consumption through high excise duties and legislative controls like bans on public smoking and strict restrictions on advertising and marketing of tobacco products as well as compulsory health warnings. The volume of cigarette sales is expected to decline by 1-4% each year over the next five years.
High excise duties on tobacco products and anti-tobacco legislation
US federal, state, and local governments, tax tobacco products for both revenue and public health purposes. High excise duties lead to increases in cigarette prices which also discourage cigarette smoking. With federal excise tax (FET) increasing from $0.39 to $1.01 per pack of 20 cigarettes in April 2009, the overall volume sales sharply decreased by 9% in 2009. Such excise taxes are as high as 30% of the net revenues for cigarettes and any further increases in excise taxes will likely lead to a fall in demand.
Governments also resort to anti-tobacco legislation and anti-smoking laws to discourage tobacco and cigarette consumption. Legislation such as those banning smoking in public places lead to a reduction in cigarette sales. Family Smoking Prevention and Tobacco Control Act, 2009 also gave the US Food & Drug Administration (FDA) the authority to regulate the tobacco industry, which may lead to greater restrictions on tobacco products. The FDA can limit what goes into tobacco products. For instance, in 2010 the organization enforced a ban on the use of strawberry, vanilla, chocolate, clove, and other such flavors in cigarettes and required the ingredients to be publicized as well as limited marketing, especially to young people. There is also a risk of ban or restrictions on menthol cigarettes that currently comprise almost 30% of cigarette sales.
Most tobacco and cigarette businesses today follow a Price-Profit First Strategy and enjoy significant room for strong net pricing and margin expansion. Despite declining cigarette sales, revenues and profit margins are maintained through higher pricing.
Risks from litigation
The tobacco industry is highly susceptible to adverse litigation. Apart from the likely enormous damage payments, the negative publicity generated by such large and high profile court cases also hurt tobacco products' demand. Due to its large size and market share, Altria is more susceptible to such litigation risks.
Trefis Forecast Rationale for Smokeless Tobacco Products EBITDA Margin
Smokeless Tobacco Products Operating Margin is the ratio of smokeless products income, minus its operating expenses and depreciation, to the total revenues (net of excise) of the division. Altria reports it as 'OCI', the operating income before corporate expenses.
Smokeless products operating margin increased from 45.56% in 2009 to 63.46% in 2010. In 2013, the margin stood around 59.56%. It fell in 2014 to 51%, before increasing slightly to 52% in 2015.
Going forward, we expect margins to increase to around 53.62%, as Altria focuses more on premium smokeless brands such as Copenhagen and Skoal.
Trefis considered the following factors for its forecast:
- Strong demand could lead to higher revenues
- Unlike cigarettes, smokeless tobacco products are expected to grow at an annual rate of 3-4%. They are generally perceived to be less harmful than traditional cigarettes. Growing demand could exert an upward pressure on prices.
- This could lead to higher revenues, from higher volumes and pricing, and consequently exert an upward pressure on margins.
- Excise hike for smokeless tobacco products
- Although smokeless tobacco products have been relatively spared by excise taxes (which are about 8% compared to 30% for cigarettes in 2014), this could change as a key advisor to the FDA (Food & Drug Administration) suggested that tobacco companies do not have sufficient scientific proof to claim that smokeless tobacco products are less harmful than cigarettes. Higher taxation will see the prices of these products rising, which may have a positive impact on the margins.
- North Carolina, Minnesota, Kansas, Louisiana, the District of Columbia and three local jurisdictions have already imposed e-cigarette excise taxes. Furthermore, another 23 states considered raising the cost of vapor products in 2015.
Back to Company Overview
- Rising input costs
- The input and manufacturing costs are expected to increase in line with inflation and will depend upon tobacco crop yields and prices. Altria enters into direct contracts with tobacco farmers to control input costs.
- The tobacco procurement costs have decreased in 2014 as a program, wherein tobacco companies buy out farmer's tobacco production quotas, has been scrapped.
- Rising marketing costs
- Altria Group, Inc.’s businesses promote their products with consumer engagement programs, consumer incentives and trade promotions. Such programs include discounts, coupons, rebates, in- store display incentives, event marketing and volume-based incentives. As the company engages in more marketing activities to promote its smokeless segment, it may hurt their EBITDA margins.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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