Altria (NYSE:MO) is scheduled to announce its second quarter earnings on July 23. We will be closely watching the y-o-y variance in the company’s cigarette shipment volume during the quarter. In addition to health concerns, the growing popularity of e-cigarettes is accelerating the decline in traditional cigarettes sales in the U.S. (See: Altria Lights Up Earnings Despite Sliding Cigarette Volumes)
We expect the trend to exhibit itself in Altria’s second quarter earnings as well. The company is currently unable to tap the growing popularity of e-cigarettes as it has yet to launch its first e-cigarette brand in the U.S. It will therefore be interesting to see if Altria can deliver earnings growth through pricing measures on traditional cigarettes while growing or sustaining its leading volume market share.
Cigarette Volumes To Decline
According to our estimates, Altria’s smokable products division that sells cigarettes and cigars makes up almost 70% of the company’s total value. The division operates in a very challenging regulatory environment marked by highly restrictive marketing rules and ever-increasing indirect taxes. Moreover, the growing use of smokeless tobacco products and electronic cigarettes due to increasing health consciousness among consumers is further aggravating the operating conditions of cigarette manufacturers. The consumption of traditional cigarettes in the U.S. has dropped by ~10% in volume since 2009. We expect the accelerating trend to pose a stiff challenge to the company in the long run.
Pricing Holds The Key
Despite all the challenges faced by the tobacco industry in the U.S., its dollar value has actually growing steadily over the years. This is because the Big Tobacco companies have been able to more than offset the decline in cigarette consumption through pricing measures. The sticky nature of the demand for cigarettes (price elasticity of demand is ~-0.3) due to its inherent addictive nature and consumer brand loyalties has greatly helped the tobacco companies. Altria, the biggest player in the market, has been able to grow its adjusted operating income, primarily from the sale of cigarettes at more than 8% CAGR since 2009. Marlboro, the company’s flagship brand, commands more than 42% of the retail market for cigarettes in the U.S. and has held the leading position in the market for more than 30 years now. Such brand equity allows Altria to lead in pricing measures and increase its value share in the shrinking tobacco industry while maintaining decent volume share growth as well.
Noticing the recent acceleration in the decline of cigarette volumes, Altria reduced off-invoice promotional allowances on its Marlboro and L&M brands last month while raising list prices on the other brands.  It will be interesting to see if the company is able to deliver earnings growth through better revenue per cigarette during the quarter without sacrificing on its leading volume share.
Diversification To Help
Altria’s diversification into the smokeless tobacco products category insulates the company from shifting consumer preferences towards chewing tobacco and snuff. During the second quarter we expect the company to ride on the growing consumption of these products in the U.S. with its popular brands. Altria has been able to grow its revenue net of excise taxes from the division at ~7.5% CAGR, while the market for these products in the U.S. has grown at ~5% CAGR in volume since 2009. The Copenhagen and Skoal brands operated by the company hold more than 50% volume share of the retail market.  According to our estimates, the smokeless products division contributes ~20% to the company’s total value.
Along with the first quarter earnings announcement, Altria revealed its plan to enter into the e-cigarettes category during the second half of this year. The company is expected to launch MarkTen brand of e-cigarettes in the test market of Indiana by August this year. (See: Altria Enters The E-Cigarettes Market Seizing On Its Growth Potential) This is a very important move for the company as it will help reduce the operating risk arising from growing consumption of e-cigarettes at the expense of their traditional counterparts.
We will be looking for any updates on the company’s entry plans into the emerging segment. Although e-cigarettes is a very small market as of now – in terms of both volumes and revenue – it has been growing at a very rapid pace. At $500 million in 2012, the market for these vapor devices is expected to double to $1 billion in 2013. Increased awareness and trial, as well as growing retail distribution are some of the key factors driving growth in the category.
We will be updating our $37 price estimate for Altria based on the second quarter earnings release.Notes:
- PM USA Reducing Off-Invoice Promotional Allowances, cspnet.com [↩]
- Company SEC Filings, sec.gov [↩]