Why We Feel Altria Has Substantial Upside Potential

+4.83%
Upside
43.62
Market
45.73
Trefis
MO: Altria Group logo
MO
Altria Group

Altria‘s (NYSE:MO) stock is down almost 18% this year, and while a few factors responsible for this are company-related, certain developments outside their control have also resulted in the decline. The company missed consensus estimates on revenues in the Q4 2017 and Q2 2018, and has posted a big decline in cigarette volumes this year. Besides the above, certain decisions by the FDA have also played a major role in the decline in Altria’s stock price. At the beginning of the year, news broke regarding the rejection of Philip Morris International‘s (NYSE:PM) proposed claim that its iQOS device presents less of a health risk than traditional cigarettes by an advisory panel instituted by the FDA. 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. The only thing that has given the stock a respite is the mention of the fact the company is “exploring options” in the marijuana space, leading to a 2% increase in the share price on September 5th.

We have a $71 price estimate for Altria, which is significantly higher than the current market price. The charts have been made using our new, interactive platform. You can click here for our interactive dashboard on Our Outlook For Altria In FY 2018 to modify the assumptions and gauge the impact on the company’s revenue, earnings, and price per share metrics.

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Why The Aforementioned Factors Should Not Matter So Much

1. Revenue Miss And Shipment Volume Decline: It is not an unknown fact that the smoking rate has been falling, with the U.S. witnessing one of the steepest declines in the world. In the face of this, a majority of the company’s revenue growth in the past has been a result of increasing the prices of tobacco products. However, given a higher volume decline than in the recent past, the smokeable segment, which forms a large chunk of the company’s sales, has been witnessing a fall in revenue. The company is instead placing a greater focus on its smokeless and innovative products segment, which have been reporting healthy growth. Moreover, given the stock price decline, the company is looking at other ways to improve shareholder returns. No doubt helped by the reduction in the tax rate, Altria has upped its share repurchase program. Altria repurchased $950 million in shares in the first half of FY 2018 reducing its share count by 15.6 million. The company has a little over $1 billion left in the repurchase program, which is expected to be completed by the end of Q2 2019. The tobacco giant also recently announced a massive 14.3% dividend increase, on top of the dividend hike earlier in the year, taking the total increase to 21% over the previous year.

2. Rejection of iQOS Reduced Risk Claim: Philip Morris is currently trying to gain FDA approval to start selling its heat-not-burn tobacco device called iQOS with a reduced risk claim in the US. Once iQOS gets the go-ahead, Altria will get exclusive rights to sell these products in the US. While a possibility of a rejection of the claim can be considered a significant setback, the first thing to consider is that the advisory panel’s recommendation is exactly that – it is a recommendation; it is not binding. Moreover, this recommendation is only for the purposes of its marketing, and not for its sale. This means that if the recommendations are accepted, Altria/Philip Morris would not be able to claim its iQOS device is less risky. The actual permission to sell this device is via a different application filed with the FDA. And hence, this recommendation has no bearing on whether Altria will get a green light to sell this device in the US.

3. Reduction Of Nicotine Content In Cigarettes: 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. Stocks of companies like Altria tanked in the aftermath of this proposal. 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 Altria’s iQOS product.

4. Restriction On Flavors In Cigarettes: To prevent the youth from using tobacco, the FDA is having a closer look into flavors such as menthol in cigarettes and the fruit and candy-flavored little cigars and cigarillos. On the flip side, it is also considering the fact that the addition of such flavors to e-cigarettes may help regular smokers to switch to less harmful tobacco products. Fear that such a step could further lower Altria’s sales spooked investors. However, given Altria’s dominant position in the non-flavored cigarette market (Marlboro has an over 50% share in the cigarette market), as well as the relative price inelasticity of tobacco products, the company has been able to increase its revenue per unit, and consequently its sales, without influencing the demand significantly.

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