Altria (NYSE:MO) recently delivered strong Q2 results, driven by the robust growth of its smokeless products and financial services divisions, complemented by the increase in value of its investment in SABMiller. The company primarily manufactures and sells cigarettes exclusively in the U.S., with its brand portfolio including well known names such as Marlboro and L&M.
We currently have a Trefis price estimate of $34 for Altria, which is about 4% below the market price.
Declining U.S. Cigarette Market
One of the trends we have factored into our price estimate is the declining market size of cigarettes in the U.S. Reasons for this include regulatory measures enforced by the FDA, smokers moving to alternative nicotine products such as lozenge and e-cigarettes, and the growing awareness and health consciousness among the general population. We forecast the market size of cigarettes in the U.S. to decline at an annual rate of around 1.5-2% during our forecast period.
10% Downside from Faster Market Decline
If there is a sharper decline, say an annual rate of 3.5-4%, there would be a 10% downside to our price estimate. One reason for such a decline could be a higher rate of adoption of alternative tobacco products, which are currently estimated to constitute around 1% of the $90 billion market for tobacco products in the U.S. Tobacco companies already recognize the potential of such products, and are looking to grow their non-cigarette divisions. Altria already has a number of such products in the market, such as Verve and dissolvable tobacco sticks under the Marlboro brand name. 
Another reason for the sharper decline could be an increase in excise duties on cigarettes. Net excise on cigarettes is currently 31.8% of revenues. We forecast it to increase to around 35% by the end of our forecast period. Tax increases are usually passed on to consumers through higher cigarette prices. Higher prices have already forced many consumers to look for alternative smokeable/non-smokeable products, such as cigars, rolling tobacco and chewing tobacco.  A steeper increase in taxes could speed up this trend.
10% Upside from Slower Market Decline
On the other hand, if there is a more modest decline in the cigarette market size during our forecast period, at a rate of say 0-0.5%, our price estimate could see a 10% upside.
We also note that an increase/decrease in the cigarette market size would be partially offset by a corresponding decrease/increase in the market for alternative tobacco products. As previously mentioned, Altria has a smokeless products division, which sells products such as nicotine lozenge, chewing tobacco and dissolvable tobacco sticks. We estimate that the division constitutes around 16% of the company’s stock price.Notes:
- Pina Colada E-Cigs Leading Push Into Smokeless Tobacco, Businessweek, August 2012 [↩]
- Big Cigars Offers Way for Smokers to Save, NY Times, August 2012 [↩]