Altria’s Q4 2014 Earnings: Business As Usual

The Altria Group (NYSE:MO) announced its fourth quarter and year-end results for 2014 on January 30. It was a case of business as usual for the company. Net revenues showed a 3% year-on-year increase due to the strong pricing of the smokable (cigarettes and cigars) category products in Q4 2014. This increase overshadowed a smaller increase in overhead expenses to raise operating income by 6.3%. For the entire year, adjusted diluted EPS increased 8% year on year. ^[1]

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Cigarette Category Dynamics

The improvement in revenue was led by the smokables category. In this category, there was an improvement in pricing and a moderation in the decline of volumes. The improvement in pricing from Q3 2014 continued into Q4. This was facilitated by an improvement in economic indicators. As noted by Altria’s CEO, unemployment has come down, housing statistics are improving and the consumer sentiment index is the highest since 2004. ^[2] This resurgence in economic conditions may also have had a role to play in the moderation in the decline of cigarette sale volumes. While the decline for the industry has been roughly 3.5% on average over the last four years, Altria has done better by limiting it to 3%. In Q4 2014, Altria’s decline in cigarette sales volume was 2%, as opposed to 2.5% for the industry. ^[1] This could explain why Altria’s retail market share has increased by 0.1 percentage points in Q4 2014.

Impact Of Innovative Products

A promising new addition to the smokables product lineup is Marlboro Menthol Rich Blue. The distribution of this product was expanded in November 2014 to 28 states. Menthol is the only flavor allowed in cigarettes after the U.S. FDA banned all other flavors in 2009. ^[3] In that year, Altria had only an 18% share of this market, whereas rival Lorillard’s Newport brand controlled a third of the market. ^[4] This segment currently constitutes a third of the U.S. cigarette market. Lorillard has grown its market share to 40%, while Altria has grown to garner a 26% market share. ^[5] According to management, Altria’s new product in this category, Rich Blue, is off to a good start. ^[1]

The category considered most innovative for the company is e-cigarettes. Nu Mark, Altria’s operating company in this segment, completed the national roll-out of its brand Mark Ten. It achieved distribution in over 130,000 stores. It also introduced a new variant that has a 2.5% nicotine concentration by weight. It is available with a menthol flavor as well. The company had claimed in its Q3 2014 earnings call that it was a top three brand in the category by market share. This time around, that claim has been diluted to “among the top e-vapor brands”. Given that there were apprehensions that the brand is failing to secure repeat purchases, it could be facing challenges gaining market share. Analysts, however, have opined that Altria will eventually dominate the e-cigarette market due to its deep pockets and wide distribution. ^[6]

A Note On Expenses

On the expense front, Altria has benefited from a regulatory windfall. The Fair and Equitable Tobacco Reform Act (FETRA) expired this quarter. This was a program aimed at the industry funded buyout of tobacco farming quota holders. It was enacted in 2004 to protect tobacco farmers who had earlier benefited from high tobacco prices ensured through production quotas. With a decline in the demand for tobacco, many of them were facing threat of closure. The industry was asked to buy out their quotas. This was costing Altria $500 million each year. With the winding up of the program, Altria has been spared this expense. ^[7]

Altria did experience increased expenses related to marketing and R&D. These were up $200 million in 2014 when compared with 2013. According to management, the most important contributor to this increase is the e-vapor category. The R&D involved in creating the product pipeline of Nu Mark was a constituent of this expense. Another contribution came from the marketing efforts to support this category’s launch. ^[1] If the e-cigarette category continues to be volatile, these expenses could persist and impact Altria in 2015 as well.

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1. Altria Group Q4 2014 Earnings Call Transcript [↩] [↩] [↩] [↩]
2. January Consumer Index Highest Since 2004 [↩]
3. Reynolds Lorillard Deal [↩]
4. Altria Introduces Menthol Cigarettes [↩]
5. Newport Cigarettes Menthol Strategy [↩]
6. Only One Winner In E-Cig War [↩]
7. Altria To Profit From Expiration Of Law [↩]