Altria Group, Inc. Company
- Smokeable Products constitute 70% of the Trefis price estimate for Altria Group, Inc.'s stock.
- Smokeless Products constitute 14% of the Trefis price estimate for Altria Group, Inc.'s stock.
WHAT HAS CHANGED?
- Impact of Coronavirus
- MO stock dropped over 30% since January 31, 2020, when the World Health organization (WHO) declared a global health emergency in wake of coronavirus, to $31 in March 2020. Tobacco stocks are generally viewed as good defensive bets through such crises. Post this, Altria stock saw an impressive rise of more than 50% from its March 2020 lows of this year. Despite a strong rally, at the current price of $49 on 25th August 2021, we believe Altria’s stock is still undervalued. In spite of a healthy rise over recent months, Altria’s stock has underperformed the market as the drop in the stock price during the coronavirus crisis was much less than the broader market’s drop in the first place. Thus, the recovery has been lower than the market. We believe that the gradual lifting of lockdowns will lead to higher shipments and revenues in 2021 and 2022 as supply constraints ease, leading to a rise in the stock price to reach close to $54 in the near term.
- FY2020 Results
- Altria reported net revenue of $26.2 billion in 2020, marking a rise of 4% compared to 2019. Higher revenue was primarily due to higher net revenues in the smokeable products as well as smokeless tobacco products segment. Cigarette volume declined due to changing consumer preferences and supply constraints, but this was offset by higher pricing which led to increase in revenues. Shipments in the smokeless tobacco segment increased along with the industry growth trends and higher pricing along with lower promotional investments, and millennials moving away from combustible products. The company reported a net profit of $2.40 per share in 2020 as against reported loss of $0.70/share in 2019. Earlier year loss was primarily driven by $8.6 billion of impairment of Altria's investment in JUUL, due to increased likelihood of U.S. Food & Drug Administration (FDA) action to remove flavored e-vapor products from the market pending a market authorization decision, various e-vapor bans put in place by certain cities and states in the U.S. and in certain international markets. The impairment charge in 2020 was $2.6 billion, much lower than what was reported in 2019.
- Q3 2021 Performance
- Altria reported net revenue of $6.8 billion in Q3 2021, marking a decline of close to 5% compared to Q3 2020. Lower revenue was primarily due to decrease in smokeable tobacco products. Cigarette shipment declined almost 13% due to industry’s rate of decline and trade inventory movements. Marlboro HeatSticks retail sales volume increased by over 20% sequentially, primarily driven by broader distribution outside of established metro markets. The company reported diluted EPS of $1.22 per share in Q3 2021, 2.5% higher than in Q3 2020, driven by higher adjusted earnings from Altria’s equity investment in ABI, lower adjusted income tax rate, lower interest expense and fewer shares outstanding.
- Other factors to watch out for:
- Altria, in partnership with Philip Morris, submitted a Modified Risk Tobacco Product Application (MRTPA) with the U.S. FDA for iQOS, its heat-not-burn tobacco product on December 5, 2016. Philip Morris International's proposed claim that its iQOS device presents less of a health risk than traditional cigarettes by an advisory panel instituted by the FDA. Philip Morris has received the FDA approval to start selling its heat-not-burn tobacco device called iQOS with a reduced risk claim in the US in early 2019. Altria (NYSE:MO) has gotten the exclusive rights to sell these products in the US. Moreover, as Philip Morris was the first company to get US approval to market a tobacco product as being less harmful than traditional cigarettes, they would have a significant marketing advantage over other reduced risk tobacco products.
- The FDA plans to limit the nicotine content in "combustible cigarettes" to non-addictive levels, in order to prevent thousands of deaths and billions of financial costs related to tobacco use. This surprising move caused stocks of tobacco companies to plummet on July 28, with Altria plunging almost 20% at one point, before recovering to a 9.5% decline. If the FDA does succeed in getting its proposal passed, it will inevitably impact the earnings of the company. Some reports suggest that if cigarettes in the future have lower levels of nicotine in them, addicts will end up smoking more to get their "nicotine fix." Hence, the cigarette volumes for Altria could actually go up. However, this is highly unlikely. A study by the New England Journal of Medicine has shown that smoking compensation does not occur when smokers are given cigarettes with nicotine levels low enough not to be addictive. If Altria was just a cigarette company, it would have faced a significant drop in its earnings. However, Altria has a diversified business, including a 10% stake in Anheuser Busch. While the company still gets majority of its revenues from its smokeable segment, the company can instead focus on its smokeless segment to recover some of the losses.
- Recently, the FDA ordered five brands – Juul, British American Tobacco's Vuse, Altria's MarkTen, Imperial Brands' Blu E-cigs, and Japan Tobacco's Logic – to submit their plans of discouraging use of their products by teens within 60 days. In response to this, Altria is removing its MarkTen Elite and Apex by MarkTen pod-based products until these products receive a market order from the FDA, and has stopped the sale of all flavors besides tobacco, menthol, and mint. On the face of it, an FDA crackdown on e-cigarettes – one of Altria's fastest growing segments – should worry investors. However, when the crackdown also targets one of its biggest competitors in the space, which controls close to three-fourths of the market, it may actually be a good thing. Just three years after its formation, Juul Labs has already reached a valuation of $15 billion, as it continues its tremendous growth in this fast increasing market. Its market share has spiked from 32% in November 2017, to 60% in April, and further to almost 73% by September. On the other hand, in the year ended January 27, 2018, MarkTen garnered close to $200 million in sales. This forms a tiny fraction of the $25.6 billion total revenues Altria achieved in FY 2017. As a consequence of the increased regulatory environment, the company announced the discontinuation of production and distribution of all MarkTen and Green Smoke e-vapor products, and VERVE oral nicotine-containing products.
- Altria recently announced the acquisition of a 45% equity stake in Cronos Group, at a price of CAD $16.25 per share, for an aggregate investment of approximately USD $1.8 billion. This comes at a time when interest in marijuana is soaring, amid legalization of recreational marijuana in multiple U.S. states and in Canada, as well as an increasing use of cannabis for medicinal purposes. Accounting for both legal and black market sales, the total demand for marijuana in the United States is estimated at $52.5 billion, per the Marijuana Business Daily. On the other hand, cigarette sales have been on the decline, as fewer young people have taken to smoking. Per the U.S. Centers for Disease Control and Prevention, last year cigarette smoking fell to its lowest level on record. This is likely causing tobacco companies to hedge their bets by looking at marijuana, which potentially has lower risks of causing diseases such as cancer, while also appealing to younger users.
- In December 2018, Altria announced that it had signed a $12.8 billion investment deal to acquire a 35% stake in JUUL Labs Inc. Investing in the US leader in e-vapor will help Altria in preparing for a future where adult smokers overwhelmingly choose non-combustible products over cigarettes. JUUL has a deep innovation pipeline and currently operates in 8 countries with rapid international expansion plans. As today's younger generation is not taking to cigarettes in such a large number, a 35% stake in a company that represents ~30% of the total US e-vapor category, will help Altria in complementing its non-combustible offerings in the smokeless category. Along with its investment in Cronos group, Altria's investment in JUUL is expected to strengthen its financial profile and enhance future growth prospects. The $12.8 billion investment is financed through a $14.6 billion term loan facility of which $1.8 billion remains undrawn.
POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE
Revenue per Smokeable Product: We currently estimate revenue per smokeable product unit to increase by ~20% over the course of the Trefis forecast period, which would suffice to offset the current cigarettes industry volume decline. However, it is also possible that the annual increase in revenue per cigarette is lower than expected due to a lower room for higher pricing. A 1% annual rate of increase would imply a 9% downside to the Trefis price estimate.
Altria Group, Inc. (previously named Philip Morris Companies Inc.) is one the largest tobacco corporations in the world and the parent company of Philip Morris USA, John Middleton Inc., United States Smokeless Tobacco Inc., Philip Morris Capital Corporation, and Chateau Ste. Michelle Wine Estates. The company, formerly owned Kraft Foods (KFT) and Philip Morris International (PM), which housed its international tobacco business. In January 2009, Altria Group completed the acquisition of UST Inc., a moist smokeless tobacco manufacturer, and owner of the Chateau Ste. Michelle Wine Estates. In addition, proceeding the combination of Anheuser-Busch InBev and SABMiller, Altria attained a 10.2% ownership in the entity.
The brand portfolios of Altria’s tobacco operating companies include well-known names such as Marlboro, Copenhagen, Skoal, and Black & Mild. Ste. Michelle produces and markets premium wines sold under various labels, including Chateau Ste. Michelle and Columbia Crest. It exclusively distributes and markets Antinori, Champagne Nicolas Feuillatte, and Villa Maria Estate products in the United States.
SOURCES OF VALUE
Cigarettes and cigars are the most valuable division with about 70% contribution to Altria's value
Cigarettes and cigars are the most valuable division of Altria Group with about 70% contribution to its stock value. Philip Morris USA occupies more than 49% retail share in the US cigarettes market. It sold 101.43 billion cigarettes in 2020, with Marlboro being the most popular cigarette brand occupying a giant retail share of 43% by itself.
Growth in smokeless tobacco products
Smokeless products is a high growth niche segment of tobacco products in the US and is projected to grow at an annual rate of around 6% to 10% over the next few years. Altria currently occupies almost 54% of the market share in the US in terms of volume of sales with its leading smokeless tobacco brands which include Copenhagen, and Skoal.
Declining tobacco consumption
The volume of tobacco products sales has been declining as a result of growing health consciousness among people about the extreme health risks of smoking. Federal and state governments in the U.S. have also been discouraging tobacco consumption through high excise duties and legislative controls like bans on public smoking and strict restrictions on advertising and marketing of tobacco products as well as compulsory health warnings. The volume of cigarette sales is expected to decline by close to 4% each year over the next five years.
High excise duties on tobacco products and anti-tobacco legislation
US federal, state, and local governments, tax tobacco products for both revenue and public health purposes. High excise duties lead to increases in cigarette prices which also discourage cigarette smoking.
A development that dampened the results for the company in 2017 and 2018 was the tax hike in California. Since California is a high volume state, it will negatively impact the revenues for the company. Furthermore, there are also proposals in several other states to raise the excise taxes further.
Governments also resort to anti-tobacco legislation and anti-smoking laws to discourage tobacco and cigarette consumption. Legislation such as those banning smoking in public places leads to a reduction in cigarette sales. Family Smoking Prevention and Tobacco Control Act, 2009 also gave the US Food & Drug Administration (FDA) the authority to regulate the tobacco industry, which may lead to greater restrictions on tobacco products. The FDA can limit what goes into tobacco products. For instance, in 2010 the organization enforced a ban on the use of strawberry, vanilla, chocolate, clove, and other such flavors in cigarettes and required the ingredients to be publicized as well as limited marketing, especially to young people. There is also a risk of ban or restrictions on menthol cigarettes that currently comprise almost 30% of cigarette sales.
Most tobacco and cigarette businesses today follow a Price-Profit First Strategy and enjoy a significant room for strong net pricing and margin expansion. Despite declining cigarette sales, revenues and profit margins are maintained through higher pricing.
Risks from litigation
The tobacco industry is highly susceptible to adverse litigation. Apart from the likely enormous damage payments, the negative publicity generated by such large and high profile court cases also hurt tobacco products' demand. Due to its large size and market share, Altria is more susceptible to such litigation risks.