Altria Group: Falling Smokeless Products Volumes a Worry

Altria Group (NYSE:MO) announced its Q1 earnings on April 29, 2012. Total revenues declined 0.8% to $5.1billion on a y-o-y basis. However, excluding excise taxes, net revenues increased 0.1% to $3.5 billion. The company reported operating income climbed 6.5% to $1.7 billion while net income grew 4% to $973 million. Strong cigarette pricing in 2011 helped the company grow its net income in spite of flat revenues. Altria is the biggest tobacco company in the U.S. and competes with Lorillard (NYSE:LO) and Reynolds American (NYSE:RAI).

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Cigarettes Perform Impressively

Cigarette volumes declined by 2.65% mainly because the company raised the prices of its cigarette brands twice in 2011 (both of which were after Q1 2011). However, strong pricing ensured that company reported operating income for the segment rose 5% to $1.44 billion. Altria has changed the reporting format from this quarter and now includes cigarettes as well as cigars under ‘Smokeable  Products’. Total revenues for the segment declined almost 1% to $5.1 billion. Since the excise taxes are fixed for a pack of cigarettes (and not a percentage of retail price), lower cigarette volumes (combined with higher retail prices) help boost profitability due to lower excise taxes.

Philip Morris USA’s cigarettes strategy focus on strong pricing of Marlboro and other premium brands such as Virginia Slims, Parliament and Benson & Hedges and promotions of discount brands such as Basic and L&M to boost volumes. For example, PM USA reduced its wholesale promotional allowance on L&M by $0.21 per pack from $0.55 to $0.34 per pack. Volume for discount brands surged almost 18%.

Cigar volumes witnessed an impressive growth of 14.3% helped by the launch of Black & Mild Wine in 2011. Moreover, the company reduced its margins to defend Black & Mild‘s market share. Cigar volumes had been stagnant for the company in the last three years so the sudden surge in the volume comes as a bit of surprise.

Smokeless Tobacco Product Volumes Decline

Revenues for the smokeless product segments, which primarily consists of Copenhagen, Skoal and Marlboro Snus, remained unchanged at $380 million. However, volumes declined 7.5% which suggests the company has resorted to stronger pricing. This is a deviation from the company’s strategy so far which had been competitively pricing its smokeless products to gain market share (by volume).

However, a stronger pricing could be detrimental for the company in the long run (although in the short run, this may increase profitability) since we expect the smokeless tobacco market to grow at an annual rate of 4%. Unlike cigarettes, smokeless tobacco products are growing at a healthy rate since they are perceived to relatively less harmful. Operating income for the segment remained flat at $193 million for the quarter.

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