Altria Earnings Preview: Lower Volumes, Thicker Margins Expected

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Altria Group

Altria (NYSE:MO) is scheduled to announce its 2014 second quarter earnings on July 22. 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. We expect the trend to exhibit itself in Altria’s second quarter earnings as well. It will therefore be interesting to see if the company can deliver earnings growth through pricing measures on traditional cigarettes while growing or sustaining its leading volume market share in the segment.

Although Altria has limited presence in the U.S. e-cigarettes market currently, it has recently been moving swiftly to grow its presence in the burgeoning category. During the second quarter earnings call, we will be closely watching for any updates on the national roll-out of its MarkTen e-cigarettes and early market share trends.

Altria is one of the largest tobacco companies in the U.S. with over 50% market share in cigarettes and smokeless tobacco products. The company’s brand portfolio includes well-known names such as Marlboro, Copenhagen, Skoal and Black & Mild. Cigarettes and smokeless tobacco products make up more than 75% of Altria’s total value by our estimates. We currently have a $43 price estimate for Altria, which is around 5% above its current market price.

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See Our Complete Analysis For Altria

Declining Consumption Of Traditional Cigarettes

According to our estimates, Altria’s smokable products division that sells cigarettes and cigars makes up almost 65% 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. [1]

Pricing Led Margin Improvement To Drive Growth

Cigarette manufacturers have been able to consistently improve their operating margins through regular price hikes coupled with relatively stable input costs. This is primarily because of the sticky nature of the demand for cigarettes due to their inherent addictive nature and consumer brand loyalties. Altria being the largest player in the U.S. tobacco market has gained the most from this trend. According to our estimates, the company’s consolidated EBITDA margins, adjusted for non-recurring and non-cash items, improved by more than 450 basis points from 2009 to 2013.

This could also be attributed to the fact that it controls leading brands in both cigarettes as well as smokeless tobacco categories. 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. Last year, the company was able to grow its revenue per cigarette by almost 3% y-o-y, while excise taxes and other costs per cigarette remained largely stable. We expect the trend to manifest itself in Altria’s second quarter earnings as well. [1]

Diversification Key To Sustained Earnings Growth

Under the given circumstances, we believe that Altria’s diverse portfolio, which apart from Marlboro and other cigarette brands also includes leading smokeless tobacco brands, Chateau Ste. Michelle and Columbia Crestwine brands, as well as a 26.9% stake in the world’s second largest brewer, SABMiller, which is one of its biggest assets. The company’s leading position in the smokeless tobacco category has somewhat insulated it from consumers opting for chewing tobacco and snuff instead of cigarettes, as its Copenhagen and Skoalbrands hold more than 50% share of the U.S. smokeless tobacco market.

Altria would like to get into a similar position in the burgeoning e-cigarettes market in the U.S., which is estimated to have tripled in size from around $500 million in 2012 to $1.5 billion last year. The company has made some quick moves over the past few months in order to achieve this target. It started selling its MarkTen e-cigarettes in the test markets of Indiana and Arizona in the second half of last year. Encouraged by positive results, the company started rolling out the product nationally last month.

Additionally, Altria completed the acquisition of Green Smoke Inc.’s e-cigarettes business during the first quarter in order to diversify its product offering in the category. Being one of the premium e-cigarette brands in the U.S., Green Smoke also fits well with Altria’s overall marketing strategy focused on premium brands. Apart from this, Altria also entered into an exclusive agreement with Philip Morris International (NYSE:PM) to commercialize its e-cigarette brands internationally. (See: Altria Set To Pose A Stiff Challenge To Existing E-Cigarette Leaders)

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Notes:
  1. Altria SEC Filings, sec.gov [] []