Key Reasons Why We Are Bullish On Altria

by Trefis Team
+10.36%
Upside
65.00
Market
71.73
Trefis
MO
Altria Group, Inc.
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An announcement by the US Food and Drug Administration (FDA) regarding the nicotine levels in cigarettes sent tobacco stocks into a tizzy. On July 28, the organization stated its 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, with Altria (NYSE:MO) plunging almost 20% at one point, before recovering to a 9.5% decline. Altria’s shares have not recovered since then, leaving us to believe there is a significant upside to the stock. Below we’ll list some reasons which reiterate our sentiments.

1. Overreaction On Regulatory Concerns

The US has seen one of the highest declines in smoking rates in the world. Hence, a fall in cigarette volumes is a given eventuality. However, if such a step is taken by the FDA , it may cause a sudden and significant drop in the volumes. One thing that needs to be considered is that it is not certain that such a proposal will get passed. And even if it does, it will take a long time before it happens. For the foreseeable future, it will have no impact on the company’s earnings, and so, the immense drop in the share price may be an overreaction by the market. Furthermore, addiction is not the only reason that people smoke, and so the decline in volumes in the future may not be as magnified as people are estimating. Moreover, if the FDA’s purpose is to reduce the smoking of cigarettes, it may actually result in better tax treatment for the company’s iQOS product.

2. The iQOS Opportunity

The FDA has begun its review of Philip Morris’ modified risk tobacco product application for iQOS in late May. Once iQOS gets a go ahead, Altria will get exclusive rights to sell these products in the US. According to Reuters, Philip Morris is the first company to seek US approval to market a tobacco product as being less harmful than traditional cigarettes since the new laws were introduced. And hence, logically, if they are also the first company to receive approval from the FDA, they will hold significant marketing advantage over other reduced risk tobacco products.

iQOS has shown significant growth in all markets it has been launched in till date. Japan is the only country in which the national expansion has occurred and the nation has boasted the strongest growth rates for iQOS among all nations. In the recently released second quarter results for Philip Morris, it was noted that the product carried on with its strong sequential growth, reflected in the weekly offtake shares for Marlboro HeatSticks. The brand closed out the quarter with a weekly offtake share of 12.7% nationally.

3. Dominant Position In The US

Altria’s Marlboro brand is the number one brand in the US, and has a 44% share in the country’s tobacco market. The addictive nature of cigarettes not only builds a high level of brand loyalty among customers, but it also makes the products less price elastic. Altria routinely undertakes tobacco price hikes twice a year. Given the massive share that Altria has in the market, its Marlboro cigarettes can be considered even less vulnerable to price hikes. The company as a whole has a commanding 51.4% share of the cigarette market. This ensures that the revenue of the company can continue to increase, despite the declining volume of cigarettes sold.

4. Scope Of The Smokeless And Innovative Products Segment

The FDA’s announcement seems to be more focused on reducing the consumption of “combustible cigarettes.” Hence, the other ways of consuming tobacco, such as through e-cigarettes and chewable tobacco, could be a focus for Altria going forward. While these products provide nicotine as well, they may pose less of a harm to consumers given their non-combustible method of consumption. These are both markets in which Altria has a significant presence. Its smokeless products segment delivered a revenue increase of 8.6% in the latest reported quarter. The company’s leading brands, Copenhagen and Skoal, each represent more than $1 billion in annual retail sales. Moreover, in e-vapor, Nu Mark’s MarkTen brand continued to grow its volume and retail share. It is currently the number two e-vapor brand in the country, with a national retail market share of ~13% in mainstream channels. While these segments contribute only a small proportion of Altria’s earnings currently, a shift towards these products in the future could be an offset for the losses from cigarette sales. A higher sell-rate of these products could also help in improving their margins.

See Our Complete Analysis For Altria

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Altria.
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