Altria Q2 Earnings Preview: Pricing And Share Gains Could Ensure Positive Results

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Altria Group

America’s leading tobacco giant, Altria (NYSE:MO), is set to report its fiscal second quarter earnings on July 29. The first quarter of the year proved to be a strong one for Altria, when the company managed to clock in an approximate 5% increase in year-on-year revenues. The quarter was also supported by positive volume movements at 1.6% against a “moderation in industry decline rates” and share gains, particularly for the key brand, Marlboro. [1] We believe that Altria could report solid results going into Q2 as well. Here is a snapshot of what could work for Altria and what stands to deter prospects.

What could work in Q2?

According to Trefis estimates, Altria’s smokable and smokeless products, account for over 80% of the company’s valuation. Altria’s performance in Q1, along with the company’s strategies to further garner sales from these channels could result in strong performance even in Q2.

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— First, let’s look at the company’s performance within the smokable product division and what Q2 might have in store for the segment. In Q1, operating income from Altria’s smokable product division registered double-digit growth. This was primarily guided by share gains for a number of key brands such as Marlboro and L&M. Moreover, these brands actually gained in terms of shipment volumes, with Marlboro shipments increasing 1.2%, and discount brands growing a solid 8.6%. [2] Furthermore, these numbers were achieved even as total industry volumes declined 0.5%, with the discount segment declining even more.

Altria also benefited in Q1 from narrowing price gaps, as players in the lower end of the market continued to increase prices at a faster rate to counter a declining market. This could go on to benefit Altria even in Q2, in terms of volumes and share gains, as consumers trade up to better quality cigarettes within the company’s portfolio. Moreover, the quarter could continue to benefit from prior investments in building Marlboro, with Marlboro Black and Marlboro Architecture continuing to provide momentum for the brand in the quarter.

— Next, let’s look at the company’s performance in growing categories such as smokeless products and innovative tobacco products. In order to offset losses from ever declining industry volumes in the smokable products category, Altria has turned its attention to building a strong smokeless and innovative product portfolio. In the smokeless category, Altria managed to deliver a 4% increase in segment volumes in Q1, beating the industry growth of 2% as brands such as Copenhagen and Skoal managed to gain share points. Q2 could see further strength from this segment, both, as the overall segment grows, and as key brands continue to gain strength in the market.

A more promising category to watch out for is the innovative tobacco segment, where Altria’s subsidiary Nu Mark extended its new and improved e-vapor offering, MarkTen XL, to a number of key markets. E-cigarettes in the U.S. have been witnessing unprecedented growth and Altria’s MarkTenXL, with better battery power and a wider range of flavors, could help the company get a bigger share of the pie in this realm. Furthermore, the company has indicated continued investment and innovation in this growing category, which could aid sales going into Q2 and beyond.

Industry dynamics to watch out for 

While we expect Altria to deliver positive results in Q2, the company could very well see the impact of the much talked about Reynolds-Lorillard merger, which was given FTC clearance earlier this year. The merger between America’s number two and number three firms in the tobacco space, is expected to make the post-merger entity a much stronger competitive force against Altria, with close to 34% of the market, from about 28% pre-merger. [3] While on the one hand, a higher degree of consolidation might just work in Altria’s favor in terms of deterring further entrants and ensuring stronger pricing power, it could also mean further competition, particularly in the menthol and e-cigarette segments. For one, the post merger Reynolds is expected to have a clear advantage in the menthol category, with America’s top brand Newport, in its portfolio. As Reynolds and Lorillard combine forces in terms of branding, marketing, and distribution, Altria’s Marlboro Menthol could face tougher times going forward. Even in the e-cigarette realm, Altria’s MarkTen could face stiffer competition from Reynolds’ Vuse (currently holds about 35% of the market), especially since the brand could gain further traction from distribution and marketing synergies coming in from Lorillard, an experienced player in e-cigarettes.

In spite of these potential headwinds, we remain optimistic on Altria’s Q2 results, especially since better macroeconomic fundamentals in the U.S. could allow some consumers to trade up to premium cigarettes from discount ones, and others at the lower end of the market could  trade up to better quality discount brands such as that offered by Altria. Furthermore, Altria has much to gain from the properties of the product that it sells, in terms of a slower response of cigarette demand to price hikes. This could help ensure revenue gains for Altria against stronger pricing, even as volumes continue to decline against increasing regulation of the tobacco industry and the growing health consciousness of consumers.

Consensus estimates from Reuters for Altria’s Q2 results, stands at 71 cents per share in EPS, as opposed to 64 cents the previous year, with revenues reaching $4.75 billion, in comparison to $3.97 billion the previous year. [4] We believe that Altria could deliver these numbers, if not beat them, against stronger pricing, further share gains, and growth coming from its innovative product offerings.

We have a price estimate of roughly $46 for the Altria Group, which is below the current market price. We will be updating our price estimate post the Q2 earnings release.

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Notes:
  1. Altria Group’s (MO) CEO Marty Barrington on Q1 2015 Results – Earnings Call Transcript []
  2. Form 10-Q, SEC []
  3. Reynolds American, Lorillard Shareholders OK Merger []
  4. Improving Economy Boosts Altria’s Marlboro Sales []