Altria Q2 Earnings Review: Solid Results Against Share Gains For Key Brands

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Tobacco giant, Altria (NYSE:MO), reported solid Q2 2015 results on July 29, with net revenues growing across the company’s smokeable and smokeless product offerings. The maker of Marlboro indicated that volumes in the quarter gained 3.1%, with volumes for the first half of the year increasing 2.4%, against better industry conditions and share gains for key brands, such as Marlboro. Given the phenomenal performance in the quarter and the first half of the fiscal year, the company has raised its full year guidance, with adjusted diluted EPS projected to fall in the $2.76-$2.81 range. Here are the key takeaways from Altria’s Q2 earnings and what we expect in the full year.

Strong Product Category Performance Aids Positive Results

Altria’s product offerings can broadly be categorized into two main categories – smokeable and smokeless. These two product categories account for over 80% of the company’s valuation. Let’s look at the company’s performance in these two segments in Q2.

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— Smokeable products: Smokeable products displayed strong category performance, with revenues net of excise increasing by over 7% in Q2 and the first half of the year. The segment benefited both on the pricing and volumes front, with Marlboro and discount brands seeing a 3% and 8.9% increase in shipment volumes in the quarter against share gains. Even among cigars, the quarter saw an almost 1% growth in the quarter, with a 5.1% growth in the six months, supported by brands such as Black & Mild.

 

Smokeless products: While smokeable products have seen an approximate 3% growth in shipment volumes, smokeless products  were not far behind, with the category growing 2.6% in Q2. Brands such as Copenhagan and Skoal continued to display strong performance, with volumes growing 3.4% even in this quarter. This was particularly aided by further share gains, with key brands growing share by 0.1 percentage points. Against this, the category managed to clock in a 4.4% increase in revenues in the quarter.

Apart from having a strong brand portfolio, Altria in the quarter continued to benefit from a slower over all decline in the industry smoking rate. Furthermore, macroeconomic fundamentals favored the business as the U.S. economy rebounded with a 2.3% growth rate in Q2 after a relatively slow start in Q1. [1] The U.S. economy is expected to continue on its growth trajectory, with Q3 seeing an approximate 3% growth. [2] If this is achieved, and if industry decline rates continue to moderate going forward, Altria could have much to gain in the full year.

E-Cigarettes and Innovative Products Could Ensure Future Success

Other than the company’s smokeable and smokeless offerings, a very promising category that is still in its inchoate phase is that of e-cigarettes and innovative tobacco products. At a time when industry volumes in cigarettes continue to decline, e-cigarettes and innovative tobacco provide high potential in terms of mitigating losses from volume declines in cigarettes and cigars. Late last year, Altria launched the MarkTen in the e-cigarette realm. This year the company introduced the MarkTen XL, a new and improved version of the MarkTen with a broader range of flavors and better battery life. The company extended the product to a number of lead markets in the U.S. earlier this year. The company’s subsidiary Nu-Mark also extended the Green Smoke e-vapor products into a number of markets in June. Although Altria’s indulgence in this realm is relatively recent, the company has indicated that the “results are encouraging.”

Altria plans to invest further to make a strong portfolio in this realm. The company will also be seen combining forces with its parent company, Philip Morris International, to “develop e-vapor products for commercialization in the U.S.” [3] If one looks at the industry growth rate in e-cigarettes and innovative products, coupled with the kind of distributional advantage that big tobacco companies are bound to have, Altria could have plenty to gain from this realm. In particular, Altria is bound to have an advantage over smaller independent manufacturers, in terms of production capacity, marketing, and distribution, in which case, MarkTen could steal market share merely on the basis of ease of availability.

Reynolds-Lorillard Merger Could Be a Factor To Watch Out For

Finally, there is the matter of the big merger between Reynolds and Lorillard, which was given FTC clearance earlier this year. Clearly, the merger has not exerted a significant impact on Altria’s ability to garner share increases in the quarter. However, the merger could go on to impact share growth for Altria going forward. 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 ahead. 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. However, the merger may just go on to be a silver lining for Altria, since a higher degree of consolidation in the tobacco space may just allow Altria a stronger hold on pricing. This is one factor that we will closely track, as the company goes into Q3.

Consensus estimates from Reuters for Altria’s Q2 results, stood 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] Altria’s Q2 results beat these estimates with $4.9 billion in revenues net of excise and 74 cents in adjusted diluted EPS, which indicates a 6.7% and 13.8% year-on-year increase, respectively. The management has also authorized a $1 billion share repurchase program, which will be completed by the end of 2016. Against the aforementioned factors, we believe that Altria is well on its way to achieve its new guidance numbers, although dynamics related to the Reynolds-Lorillard merger could exert its influence in the medium term.

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 in light of the Q2 earnings release.

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Notes:
  1. U.S. economy bounces back with 2.3% Q2 growth []
  2. United States GDP Growth Rate Forecast []
  3. Altria Group (MO) Martin J. Barrington on Q2 2015 Results – Earnings Call Transcript []
  4. Improving Economy Boosts Altria’s Marlboro Sales []