VALUATION HIGHLIGHTS

1. Smokeable Products constitute 76% of the Trefis price estimate for Altria Group, Inc.'s stock.
2. Smokeless Products constitute 16% of the Trefis price estimate for Altria Group, Inc.'s stock.

WHAT HAS CHANGED?

1. MO Stock Performance
   • MO stock has seen little change, moving slightly from levels of $40 in early January 2021 to around $40 now (ending February, 2024), vs. an increase of about 35% for the S&P 500 over this roughly 3-year period.
   • Overall, the performance of MO stock with respect to the index has been quite volatile. Returns for the stock were 16% in 2021, -4% in 2022, and -12% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 - indicating that MO underperformed the S&P in 2021 and 2023.

2. Q4 2023 Performance
   • Altria reported net revenue of $6.0 billion in Q4 2023, marking a y-o-y decline of 2.2%. This can be attributed to lower volumes for both smokable and oral tobacco products, partly offset by better price realization. The company reported diluted EPS of $1.18 per share in Q4 2023, reflecting no change over the prior-year quarter.

3. Impact of Covid-19
   • MO stock dropped over 40% to around $31 in March 2020, compared to levels of over $50 in mid-January 2020, after the World Health Organization (WHO) declared a global health emergency in the wake of coronavirus.

     Tobacco stocks are generally viewed as good defensive bets through times of crisis. Post this, Altria stock saw an impressive rise of more than 80% from its March 2020 lows to around $57 in May 2022 before falling to $40 currently (as of late February 2024).

     The fall in MO stock this year can be attributed to rising concerns of direct competition between Philip Morris and Altria, given that Phillip Morris has acquired Swedish Match. This is concerning for Altria because Swedish Match sells pouch-based smokeless tobacco, which may go up against Altria brands like Copenhagen in the U.S. market.

4. 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 is that its iQOS device presents less of a health risk than traditional cigarettes. Philip Morris 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 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. 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 were 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 the majority of its revenues from its smokable segment, the company can instead focus on its smokeless segment to recover some of the losses.
   • The U.S. FDA in 2018 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 to discourage the use of their products by teens. In response to this, Altria removed its MarkTen Elite and Apex by MarkTen pod-based products from the markets. On the face of it, an FDA crackdown on e-cigarettes – one of Altria's fastest-growing segments – should worry investors. However, the crackdown also targets one of its biggest competitors in the space, which controls close to three-fourths of the market.
   • In 2019, Altria 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 the legalization of recreational marijuana in multiple U.S. states and in Canada, as well as the increased 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. The idea of investing in the US leader in e-vapor was to prepare 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 represents ~30% of the total US e-vapor category. Along with its investment in Cronos Group, Altria's investment in JUUL was expected to strengthen its financial profile and enhance future growth prospects. The $12.8 billion investment was financed through a term loan facility. However, JUUL products were banned by the US FDA in 2022, and Altria has written down its value of JUUL stake to a mere $450 million. JUUL is currently trying to avoid bankruptcy by raising fresh capital and cutting costs.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Revenue per Smokable Product: We currently estimate revenue per smokable product unit to increase by ~20% over the course of the Trefis forecast period, which would suffice to offset the current cigarette 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 nearly a 10% downside to the Trefis price estimate.

BUSINESS SUMMARY

Altria Group, Inc. (previously named Philip Morris Companies Inc.) is one of 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 was formerly owned by 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 with 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. Altria exited the wine business in 2021.

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 U.S. cigarette 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 are a high-growth niche segment of tobacco products in the U.S. and are 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 U.S. in terms of volume of sales with its leading smokeless tobacco brands, which include Copenhagen, and Skoal.

KEY TRENDS

Declining tobacco consumption

The volume of tobacco product 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 the 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

U.S. 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.

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 U.S. Food & Drug Administration (FDA) the authority to regulate the tobacco industry, which has led 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.

Strong pricing

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 potential 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.