Delay In Industry Consolidation Expected To Keep Altria Earnings Stable

When Altria Group (NYSE: MO) held its Q2 2014 earnings conference call, it was asked multiple times about the impact on it financials of the buy-out deal between competitors, Reynolds American and Lorillard. ^[1] As it turns out, that deal has been delayed due to issues raised by the SEC. These two companies now hope to conclude the deal only by early 2015 now. ^[2] This could lift much of the uncertainty from the Altria Group’s earnings in the third quarter of this year. Issues that can have a major impact on the earnings now are the deteriorating market for cigarettes in the U.S. and the preserving of margins. We analyze the trends that can influence the Q3 2014 earnings of Altria in this article.

We have a $42.5 estimate for the value of the Altria Group share, whereas the market prices it at ~$47.5. Bloomberg Businessweek has an analysts consensus estimate of $4.7 billion for revenues and $0.68 for EPS for Altria Group in Q3 2014.

See Our Complete Analysis For Altria

Market Size Decline

One of the alarming trends for those invested in tobacco stocks has been the pickup in speed of the degrowth of the cigarette market in the U.S. While the market size was decreasing at a rate of only 3.5% for the last three years, the first half of this year has seen the market fall at 4.5%. While the company’s management had expressed faith that this rate will revert to its medium term average, a continuation of this trend would have reduced the number of cigarettes sold by the industry this quarter. As per the management comments during competitor Reynolds American’s Q2 earnings call, the industry volume declined only 2.7% in the quarter. This seems to validate the Altria management’s beliefs and may bode well for their results. ^[3] (All degrowth rates are annualized)

Evolution Of The Market Share

The scenario on market share also seems favorable to Altria. Rival, Reynolds American reported a marginal reduction in its market share over the previous quarter. As per the Reynolds American management, the industry has managed to reduce its inventory this quarter by 800 million units year on year. Reynolds American itself has contributed to only 200 million units of these. A good part of the remainder is likely to be due to Altria. This could have helped Altria defend its market share. ^[3]

We expect the category wise market shares of the company’s products to maintain the trajectory of stable and modest growth seen in the past. The company’s flagship brand, Marlboro had increased market share by 0.1 share points in the first half of this year. This is in line with the stated objective of the management to maintain margins in the smokables category while aiming for modest market share increases. ((Ref: 1))

The smokeless category provided better growth, rising 0.3 share points in the first half of the year. It may do so this quarter as well. ((Ref: 1))

Pricing And Costs

Reynolds American also reported improvements in pricing, that helped it increase its revenues in Q3 over Q2 2014. In fact, one analyst described the pricing as having been almost too high. ^[3] Given the oligopolistic nature of competition in the industry, it is likely that Altria too benefited from better than expected price increases. Higher pricing had been the major factor that helped Altria grow operating companies income in Q2 2014 as well. ^[1]

On the cost side, SG&A (Selling, General and Administrative) expenses remain a concern. In Q2, it had come in at 14% of sales, a rise of 21% year on year. The major contributor to this was the rollout of MarkTen brand of e-cigarettes across 60,000 retail stores in western U.S. ^[1] However, the competitor, Vuze from Reynolds American, has also achieved a similar rollout in Q3, gaining presence in 70,000 stores. ^[3] This could mean that Altria may have to spend more in promotions on this product going ahead as well, adding to SG&A expenses.

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1. Altria Group Q2 2014 Earnings Call Transcript, seekingalpha.com [↩] [↩] [↩]
2. SEC Filing Details Negotiations For Reynolds/Lorillard Deal [↩]
3. Reynolds American Q2 Earnings Call Transcript, seekingalpha.com [↩] [↩] [↩] [↩]