Price Increases Help Altria Deliver A Beat In The Third Quarter

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Altria Group

Altria (NYSE:MO) posted its third quarter earnings on October 25, wherein a 3% increase in revenues and a 20% growth in earnings was reported, with both metrics exceeding consensus expectations. 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, as well as the growth of its smokeless and innovative products segments. These trends continued in the third quarter, with the company noting a 3.7% fall in cigarette volumes, but a 2.7% improvement in smokeable revenues (net of excise taxes). Altria got a boost to its earnings as a result of the overhaul of the corporate tax code, which reduced the tax rate from 35% to 21%, effective January 1, 2018. Based on the performance in the first nine months, the company has now tightened its guidance to a range of $3.95 to $4.03.

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 Altria’s Performance In Q3 2018 And Estimating Its Fair Price to modify the assumptions and gauge the impact on the company’s revenue, earnings, and price per share metrics.

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Factors That May Influence Performance Going Forward

1. iQOS Launch: Philip Morris, together with Altria, is in the process of gaining FDA approval to start selling its heat-not-burn tobacco device called iQOS with a reduced risk claim in the US. With a product like iQOS in its portfolio, it could be a game-changer for the company, given the cigarette volume decline, and would ensure continued growth in the future for Altria. While PM was the first company to file for an FDA approval for its heat-not-burn device, competitor BAT has stated that it has gained approval to sell its own device in the U.S. market, and is expected to begin testing it by the end of 2018. Meanwhile, Altria stated that its initial lead market plans for iQOS are in place and the company remains hopeful for FDA authorization by year-end.

2. Marlboro Ice Expansion: In the first quarter, the company expanded Marlboro Ice nationally, a product that would appeal to adult menthol smokers, and it has continued its strong performance in Q3 as well. The brand is being sold in about 130,000 retail stores and is noted to have very high re-order rates. Given the substantial promotion Altria has been undertaking for this product, it may help to stabilize the Marlboro market share going forward.

3. Potential of Nat Sherman: This product is part of the super-premium tobacco segment, and has a “competitive share” of the market. Altria expanded the brand into 13 additional states across the western U.S., and the team is looking at further expansion opportunities. This should lead to higher volumes and has a potential of increasing the revenue per cigarette, given its premium nature.

4. Smokeless Segment Growth: Copenhagen maintained its growth and an improving market share performance in the third quarter. However, Altria’s 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. Keeping this focus in mind, the company announced its intention to expand Copenhagen’s Smooth Wintergreen to 22 states. In September, the FDA accepted and filed the company’s modified risk tobacco product application for Copenhagen Snuff.

5. Innovative Products: In e-vapor, Nu Mark grew volume by approximately 16% in Q2, and 23% for the first half, driven by expanded distribution, while also benefiting from category growth. The removal of certain products may hamper growth going forward, however, the company has stated that approximately 80% of Nu Mark’s e-vapor volume in the third quarter of 2018 will remain on the market. Consequently, we expect Nu Mark to sustain its strong growth this year.

6. Share Repurchases: Altria repurchased $367 million in shares in the third quarter, reducing its share count by 6.2 million, taking the total for the first nine months to $1.3 billion and 21.8 million shares, respectively. This was one of the factors that helped in the solid growth of the EPS in the quarter. The company has roughly $700 million left in the repurchase program, which is expected to be completed by the end of Q2 2019.

7. Excise Tax Hikes: Excise tax increases in Kentucky and Ohio went into effect from July 1, and had a 0.5% impact to cigarette industry volumes.  The two states combined represent 5% of the cigarette industry volume in the country. However, Marlboro forms over 50% of the market shares in both, which may exacerbate Altria’s volume decline.

8. E-Cigarette Crackdown: 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. Consequently, an action by the FDA in the e-cigarette industry should not be much of a dampener on Altria’s revenues.

9. Entry Into Cannabis: The cannabis market is booming, with tremendous growth expected in the coming years. According to Canopy Growth Corporation (TSX: WEED, NYSE: CGC), the potential global opportunity is expected to exceed $200 billion by 2032. On the other hand, tobacco companies have been faced with a shrinking cigarette market. In the face of this, the fact that big tobacco companies may be looking into the cannabis space should not come as much of a surprise. The management at Altria have stated that they are exploring opportunities in the category. According to The Globe And Mail, a deal between Altria and pot company Aphria (TSE: APH) may be in the cards, which we think may be a win-win for both.

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