How A Couple Of FDA Announcements Have Resulted In Altria’s Stock Being Undervalued

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Altria Group

Altria‘s (NYSE:MO) stock is down almost 15% this year, and a few factors may be responsible for this. The company missed consensus estimates on revenues in the fourth quarter of 2017, which fell 3% for the year, driven by a fall in cigarette volumes. The fact that Altria was able to grow its full-year adjusted diluted EPS by 12%, beating consensus expectations by 11 cents, on the back of higher equity earnings from its investment in Anheuser Busch, improved operating companies income, a reduced share count, and a lower tax rate, was largely overlooked by the investors. Two announcements by the FDA in March also rattled a few investors. First, the FDA announced it was working on a policy framework to lower the nicotine levels in cigarettes. A few days later, the administration stated it was considering policies to restrict the use of flavors, including menthol, strawberry, and chocolate, in tobacco products in a bid to prevent young people from getting addicted to nicotine. These developments, together with weakness in the broader equity market, resulted in a poor performance of the company’s stock year to date. The good news is that this has brought about a situation where Altria’s stock looks undervalued.

We have arrived at a price estimate of $79 for Altria, which is above the market ($60 as of March 27). This is based on an estimated revenue of $19.7 billion in FY 2018, net income of $7.7 billion, and a P/E multiple of 20. You can click here to see our interactive dashboard, and arrive at your own price estimate by modifying the different inputs.

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Our net income forecast is based on the expectation that the revenue will jump 3%, and the net income margin will increase to 38.8%, from 34% in FY 2017. The major factor that will result in the improvement of the net income margin is the lowering of the tax rate, which should immensely benefit Altria as it operates solely in the United States. The company expects its 2018 adjusted tax rate to be between 23% and 24%, primarily due to the lower corporate tax rate and lower taxes on AB InBev dividends, while in the past the metric has hovered around 35%.

Altria generates its revenues from four sources – smokeable products, smokeless products, wine, and financial services. With regards to the financial services, in 2003, PMCC (Philip Morris Capital Corp.) ceased making new investments and began focusing exclusively on managing its portfolio of finance assets in order to maximize its operating results and cash flows from its existing lease portfolio activities and asset sales. Consequently, its revenues have been declining, and we expect this trend to continue.

In the Smokeable Products division, the volume of cigarettes and cigars have been undergoing a decline, reflective of the general industry trend of reduced smoking rates. On the other hand, given Altria’s dominant position in the market, as well as the relative price inelasticity of tobacco products, the company has been able to increase its revenue per unit without influencing the demand significantly.

The smokeless segment delivered an impressive 11% operating companies income growth in 2017, despite a voluntary recall of some smokeless tobacco products. The segment is the largest, most profitable non-combustible tobacco business in the world. Copenhagen continued its growth and market share improvement in 2017. However, its other big smokeless brand – Skoal – witnessed a market share decline, as the company continued its focus on growing Copenhagen while honing its investments into Skoal to enhance profitability. Looking ahead, the company has filed an MRTP (Modified Risk Tobacco Product) application for Copenhagen Snuff. Furthermore, the company plans to expand Copenhagen Southern Blend, a premium-priced product, across the western U.S, which should drive volume and revenue-per unit growth.

Ste. Michelle Wine Estates primarily deals in premium wines and holds some popular brands such as Chateau Ste. Michelle and Columbia Crest. We expect the company to leverage its brands and premium quality to increase its effective prices. The high-priced fine wine segment suffered a decline during the economic recession as the trend was towards inconspicuous consumption as consumers traded down to value-priced wines. Now, better retail conditions in the economy, and strong consumer demand is expected to drive the growth of high-priced wines. Consequently, we expect an improvement in the volume and revenue per case metrics for the wine segment.

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