Altria Group Earnings Preview: Focus on Smokeless Products

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Altria Group

The Altria Group (NYSE:MO) is set to release its annual and Q4 2014 results on January 30. Below we take a look at what could be in store for the the company. The flagship cigarette category has been using pricing and market share gains to overcome market size reductions. Meanwhile, the smokeless and the innovative products categories have been experiencing trouble with market share gains. We analyze recent trends to get a picture of how these divisions may have fared in Q4 2014.

We have a price estimate of roughly $44 for the Altria Group, which is nearly 20% below the current market price.

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Cigarette Volumes Decline In The U.S.

During the first half of 2014, the cigarette market declined by 4%. During Q3, the rate of decline moderated to 3.5%, which Altria’s management claimed was the rate they have been expecting. [1] There are two factors that can cause the rate of decline to vary from such a forecast. The first of these is the change in the rate of decline of the number of adult smokers in the U.S. The second is the disposable income of these smokers, because this in turn determines the number of cigarettes smoked per person. We discuss these below.

The percentage of U.S. adults who smoke has seen a 3 percentage point drop between 2005 and 2013. At the start of this period, 20.9% of American adults smoked. At the end of this period, that rate was down to 17.8%. In the same time period, the number of these smokers who smoked daily fell from 80.8% to 76.9%. These trends show three important things: the user base for cigarettes is shrinking, the uptake of smoking among non-smokers is not stemming the decrease in smoking, and existing smokers are smoking less frequently. [2] Altria management expects a 2-3% annual reduction in the number of smokers. [1]

Coming to the income of smokers, there are multiple aspects to be considered here as well. Firstly, the U.S. economy has been improving, though the forecasts for GDP growth predict a quarter-on-quarter decline in the GDP growth rate. The most pessimistic forecast, by Wells Fargo, predicts a decrease of over 2 percentage points. [3] The actual GDP data release is slated for January 30, the same day Altria releases its Q4 2014 results. [4]

The second aspect influencing the purchasing power of smokers is the prevalence of smoking among poor and working class communities. [5] The economic recovery in recent years has been relatively uneven, as the incomes of poorer people have not recovered to the same extent of the more affluent. [6] Therefore, it is unlikely that tobacco companies encountered any favorable changes in the demand for cigarettes in Q4 2014.

Smokeless And Innovative Products

Noteworthy from the company’s Q3 results was the slowdown in smokeless category growth. It came in at 3%, compared to a long term trend of 5%. Management identified two reasons for this slowdown in growth. The first was a denominator or base effect, whereby the growth rate decreases because the base from which a company has to grow becomes larger over time. Secondly, increased choices for tobacco users were blamed for the slowdown in growth. This could allude to the emergence of heat-not-burn and vapor products. [1]

Management said that they are taking steps to address this slowdown in growth, such as trying to prevent competition among two of their own brands, Copenhagen and Skoal. Secondly, there is a new aggressive ad campaign to promote Skoal. In terms of innovative products, e-cigarette brand MarkTen was set to be introduced to stores in the Eastern U.S. in Q4 2014. After its roll-out in the Western U.S. across 60,000 stores in Q3 2014, the product achieved a top-three retail market share in that region. However, it was reported to be having issues securing repeat purchases from consumers. [1]

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Notes:
  1. Altria Q3 Earnings Analyst Conference Call [] [] [] []
  2. Number Of American Smokers Dwindles []
  3. 2014 Q4 U.S. GDP []
  4. U.S. Real GDP []
  5. Why Do Poor People Smoke More []
  6. Gap Between Rich, Poor Americans []