Altria’s Earnings Rely On Better Pricing For Smokes And Growth In Smokeless Products

Altria (NYSE:MO) is scheduled to announce its fourth quarter earnings on January 25. The U.S.-based tobacco company posted strong results in the third quarter with 2% y-o-y growth in both revenues and gross margin. For the nine months ended September 2012, revenues and gross margin were up 4% and 9% y-o-y respectively. Revenue growth was led (in absolute terms) by smokeable products (up 2.1% y-o-y), followed by smokeless products (up 2.6% y-o-y). Revenue growth in both the segments was driven by higher list prices and higher reported shipment volume, partially offset by higher promotional investments and higher volume growth in discount brands. Effective cost management due to the ongoing cost reduction program added to the effect of higher list prices to push operating margins higher for the company.

Altria faces a declining market for cigarettes in the U.S. and is increasingly relying on its Marlboro brand that holds more than 40% of the market and pricing to drive revenue growth. The smokeless products segment on the other hand is performing quite well, and we believe that this division has the potential to drive overall growth in medium-long term.

Declining US Cigarette Sales Volume

Excise duty hikes, resulting in higher list prices of cigarettes has been one of the biggest factors driving down the U.S. cigarette sales volume. A 10% increase in price has been estimated to reduce overall cigarette consumption among adolescents and young adults by about 4%. ^[1] Increased availability of lower risk products causing smokers to switch to smokeless tobacco products (perceived as being less harmful) and even e-cigarettes, is also seen as a reason for declining sales. Moreover, increased marketing restrictions driven by tighter legislative controls since the implementation of the The Family Smoking Prevention and Tobacco Control Act of 2009, that gave the US Food & Drug Administration (FDA) the authority to regulate the tobacco industry, have further limited the opportunities for cigarette companies.

Adjusted for inventory and other factors, cigarette sales volume for the first nine months in 2012 declined by around 0.5% y-o-y for Altria. The decline in volume was essentially seen in Marlboro and other premium brands, marketed by the company. Meanwhile, the volume in discount brands grew at an impressive rate. This was on expected lines based on the continuing trend. We expect a fairly similar performance by Altria on the volume front for the fourth quarter as well.

Growing smokeless products segment

Contrary to the cigarettes market, smokeless products’ volume in the U.S. has been growing over the last couple of years. A large portion of the consumer base for these products consists of smokers who are switching with the belief that it is a less harmful alternative to cigarette smoking. Smokeless products are also subject to far lower excise duties compared to cigarettes, leading to cheaper prices. The market size for smokeless products in the U.S. was around 1.33 billion packs/cans in 2011. We forecast it to grow at a steady rate of 3% annually, reaching almost 1.65 billion packs/cans by the end of our forecast period.

Altria’s smokeless products segment’s 2012 third-quarter and nine-month net revenues increased 2.6% and 2.8%, respectively, primarily due to higher pricing and higher volume, which partially offset by unfavorable mix due to growth of lower priced products. After adjusting for changes in trade inventories and other factors, Altria’s 2012 third-quarter domestic smokeless products shipment volume grew approximately 5% y-o-y.

We expect the trend to reflect in the company’s fourth quarter earnings as well backed by strong performance from its flagship brands in the segment, Copenhagen and Skoal, that hold more than 50% of the U.S. smokeless products market share among them.

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1. Economic Facts about U.S. Tobacco Production and Use, CDC – Lead federal agency for comprehensive tobacco prevention and control [↩]