Altria Earnings Review: Better Margins Offset Lower Volumes

by Trefis Team
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Altria Group, Inc.
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Altria’s (NYSE:MO) second quarter earnings rose higher on thicker margins due to better pricing. The company’s adjusted diluted earnings per share (EPS) grew by 4.8% y-o-y to $0.65. Altria also extended its market share in both cigarettes as well as smokeless categories, riding on the strong performance of its key brands, namely Marlboro and Copenhagen. This bolsters our faith in the company’s ability to drive future earnings growth on pricing gains, as cigarette consumption in the U.S. continues to decline. [1]

Altria revised its 2014 full-year adjusted diluted EPS guidance to be in a range of $2.54 to $2.59. The company also announced a new $1 billion share repurchase program to be completed by the end of next year. Based on the second quarter earnings announcement, we have revised our price estimate for Altria to $42.5/share, which is 16.5x our 2014 full-year adjusted diluted EPS estimate of $2.57 for the company.

See Our Complete Analysis For Altria

Lower Cigarette Sales Volume

The market for traditional cigarettes in the U.S. already faces a very challenging business environment marked by declining consumption, highly restrictive marketing rules and ever-increasing indirect taxes. According to the Centers for Disease Control and Prevention (C.D.C.), just about 42 million people, which is nearly 18% of the adult population, smoke cigarettes today in the U.S. This compares to 21% of the adult population nearly a decade ago and 43% of the adult population in 1965. [2]

On top of that, 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. Despite an impressive market share performance, Altria’s cigarette sales volume dropped by 4% y-o-y during the second quarter, primarily due to a 4.5% decline in the overall market. Since 2009, the consumption of traditional cigarettes in the U.S. has dropped by more than 14%, and we expect it to drop by another 4.5% y-o-y this year on the growing adoption of e-cigarettes, which tripled to more than $1.5 billion in sales last year.

Higher Pricing, Thicker Margins

Pricing continues to remain the key growth driver for cigarette manufacturers. Low sensitivity of consumption demand to price increases, which is primarily due to the inherently addictive nature of cigarettes, has allowed cigarette manufacturers to drive meaningful earnings growth through regular price hikes over the past several years. The trend manifested itself during Altria’s second quarter earnings as well. The company’s revenue (net of excise taxes) from the sale of cigarettes and cigars increased 0.8% y-o-y, despite a 4% decline in sales volume. Moreover, adjusted operating income from the segment increased by 3.6% y-o-y, as margins improved by 120 basis points on relatively stable per unit costs.

Apart from the addictive nature of cigarettes, Altria’s consistent earnings growth performance can also be attributed to its leading market share in the cigarettes space. Marlboro, the company’s flagship cigarette brand, now holds 44% share of the retail market in the U.S. and has been leading the market for more than 30 years now. Such brand loyalty allows Altria to lead in pricing measures and increase its value share in the shrinking tobacco industry while maintaining decent volume share growth. During the second quarter, Marlboro’s net pack price stood at $5.93, up $0.15 or almost 2.6% from the same period last year. At the same time, its retail market share also improved by 30 basis points over last year.

Diversification Bolsters 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 Crest wine brands, as well as a 26.9% stake in the world’s second largest brewer, SABMiller, 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 Skoal brands 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. During the second quarter earnings call, the company officials announced that MarkTen has already achieved strong distribution in over 60,000 stores in the Western U.S. According to the company, these stores account for more than 70% of cigarette industry volume in the Western U.S. where MarkTen is distributed.

Additionally, Altria also 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 Reports 2014 Second Quarter And First Half Results, altria.com []
  2. Reynolds In Talks To Acquire Lorillard In Merger Of Tobacco Rivals, nytimes.com []
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