Note: More details to come; changes are highlighted. Except where highlighted, no other sections of this report have been updated.
Reason for Report: 1Q18 Earnings Update
Prev. Ed.: Mar 28, 2017; 4Q17 Earnings Update
Brokers’ Recommendations: Positive: 76.9% (10); Neutral: 23.1% (3): Negative: 00.0% (0) Prev Ed: 9; 3; 0
Brokers’ Target Price: $72.18 ($5.02 from the last edition, 11 firms) Brokers’ Avg. Expected Return:29.6%
*Note: Though dated May08, 2018; share price and broker material are as of May2, 2018.
Note:The tables below for Revenue, Margins and Earnings per Share contain fewer broker materials than the broker material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Note: We do not have access to ‘Sell’ reports
Portfolio Manager Executive Summary
Altria Group Inc. is engaged in the manufacture and sale of cigarettes, smokeless products and wine in the United States and internationally. It is the parent company of Philip Morris USA (PM USA), John Middleton Inc. and Philip Morris Capital Corp. In March 2008, it spun off Philip Morris International (PMI).
Of the13firms covering the stock in the Zacks Digest Group, ten gave a positive rating while the remaining 3 were neutral. None of the firms had a negative outlook on the stock.
Buy or equivalent outlook (10/13 firms or 76.9%) – Firms expect Altria to gain from rich brand lineup whichhold significant market shares, strengthening the company’sfoothold in the tobacco industry.Moreover, the company has been keen on inventing new products, especially in its smokeless tobacco category. Firms are also hopeful regarding Altria’s technology and marketing agreement with Phillip Morris, which is currently submitted for approval to the U.S. Food and Drug Administration (FDA).If the deal is approved, Altria will be able to market iQOS products in the United States. The company has also been gaining from higher cigarette pricing. This enables Altria to continue expanding revenues, despite declines in cigarette volumes. Firms arealso encouraged with the company’s consistent efforts to return value to shareholders through dividends and share buybacks.
Neutral or equivalent outlook (3/13 firms or 23.1%) –These firms are encouraged by the company’s strong brand portfolio and leading market share in the tobacco industry. Theconsistent improvement in smokeless shipment revenues is also appealing. However,firmsare skeptical regarding the government regulations affecting the demand of tobacco products.Further, they remain concerned regarding the FDA’s strict rules to lower nicotine in cigarettes, restrictions on packaging of cigarettes as well as the sale of e-cigarettes. This is expected to affect the company’s shipment and volumes. Nevertheless, firmsare encouraged about the strategic framework with Philip Morris to commercialize reduced-risk tobacco products.
May08, 2018
Overview
Headquartered at Richmond, VA, Altria Group, Inc. was founded in 1919. It is the holding company for Philip Morris USA, Inc. (PM USA), UST LLC (UST), John Middleton Inc. and Philip Morris Capital Corporation (PMCC).
PM USA manufactures and sells cigarettes and certain smokeless products in the United States. UST manufactures and sells smokeless products and wine. John Middleton Inc. is a leading manufacturer of machine-made large cigars. PMCC is a financial company engaged primarily in leasing activities.
Altria reports under the following segments on the basis of products:
Smokeable Products: The segment, which comprises mainly of PM USA, sells major brands like Marlboro cigarettes, Virginia Slims cigarettes and Parliament cigarettes. Effective from 1Q12, cigarettes and cigars segments were merged into a single Smokeable Products segment. The cigars segment consisted of machine-made large cigars and pipe tobacco manufactured mainly by the Middleton subsidiary. The cigar segment operates mainly in the United States.
Smokeless Tobacco:The segment was formed after the company’s acquisition of UST and its smokeless tobacco business on Jan 6, 2009. The smokeless products segment includes brands like Copenhagen, Skoal, Red Seal, Husky and Marlboro Snus, a PM USA spit-less smokeless tobacco product.
Wine: Thesegment was formed after the company’s acquisition of UST and its premium wine business Ste. Michelle on Jan 6, 2009. The main brands include Chateau Ste. Michelle and Columbia Crest. The company also owns wineries or distributes wines from several other wine regions and foreign countries.
The firms identified the following aspects as critical to the evaluation of the investment merits of Altria
Key Positive Arguments / Key Negative ArgumentsStrong Brand Portfolio: Altria’s strong brand portfolio makes it a leader in the tobacco industry. Marlboro, the flagship brand, continuously adds value through product innovations.
Evolving with Changing Demand: Altria focuses on producing less harmful nicotine products to meet the changing need of consumers. Accordingly, Altria has beenexpanding presence in the e-cigarette category. The company’s MarkTen and Green Smoke e-vapor products have been performing strongly. Further, Altria has entered into a strategic agreement with Philip Morris to combine their marketing power to ramp up the market of non-combustible tobacco products.
Pricing Benefits:Altria has been gaining from rising cigarette prices. It is seen that smokers tend to absorb price increases owing to the addictive quality of cigarettes. / Declining volumes: Altria has been experiencing lower cigarette volumes for the past few quarters mainly due to rising health concerns and the ongoing anti-tobacco campaigns.
Regulation Risk: Governments around the world are imposing packaging and marketing restrictions on cigarettes. Moreover, the Food and Drug Administration has directed companies to lower nicotine level in cigarettes to make in less addictive.
Weak Wine Segment: Altria’s wine segment has been performing sluggishly. Heightened competition and dismal growth of premium wine brands have been primarily responsible for the segments weak performance.
Note: Altria’s fiscal year ends on Dec 31.
May 08, 2018
Long-Term Growth
Superior brand portfolio, stable market share growth, positive pricing environment and strong productivity gains are major positives for the company, which will help it earn profits in the challenging tobacco industry.
Altria continuously adapts to evolving demand through innovative product launches. The company has developed innovative, non-combustible nicotine-containing products to cater to the general shift toward low-risk and smokeless tobacco products. We expect such initiatives to help Altria counter the impacts from various regulations and restrictions being imposed on smokeable products.
Notably, the FDA has made it mandatory for tobacco companies to use precautionary labels on cigarette packets to dissuade customers from smoking. Per court orders, issued in October 2017, Altria and other cigarette manufacturers have been directed to put up self-critical advertisements on television and newspapers to dissuade customers from smoking. Apart from this, the court wants tobacco companies to admit that cigarettes have been made addictive, through the issuance of corrective ads.
Additionally, in July 2017 the FDA proposed to lower nicotine in cigarettes to non-addictive or minimally addictive levels. This has further raised concerns of accelerated sales declines for traditional cigarettes.Prior to this, the FDA had made it mandatory for tobacco companies to use precautionary labels on cigarette packets to dissuade customers from smoking. Per the FDA, tobacco makers must seek marketing authorization for any tobacco product introduced after Feb 15, 2007. The law was extended to include e-cigarettes, pipe tobacco, cigars and hookah, effective from August 2016.
Moreover, the European Union and the FDA have proposed a ban on menthol in accordance with the Tobacco Control Act which essentially states that menthol cigarettes have an adverse impact on public health and suggests its removal. Also, this ban will create a serious black market for these products, which would be highly detrimental to the tobacco companies.
To cope with such regulations, Altria has been undertaking significant efforts, which should drive growth in the long term. Incidentally, itsflagship MarkTen e-cigarette brand (launched in 2014) and Green Smoke e-vapor products are some of the products performing strongly in the smokeless category. MarkTen XL — a variant on MarkTen launched by the company in 2016 have been encouraging in lead markets. In fact, MarkTen is now a leading e-vapor brand in the United States.
Further, Altria’s marketing and technology agreement with Philip Morris under which the latter markets Altria’s MarkTen e-cigarettes internationally and the Altria distributes two of Philip Morris’ heated tobacco products in the U.S. is expected to boost businesses of both the companies. The companies have also decided to partner on a regulatory engagement related to the products. Additionally, the companies extended their technology sharing agreement in July 2015 to work on a joint research, development and technology-sharing framework for developing unconventional cigarettes. On Mar 31, 2017, Philip Morris applied for pre-market approval of its iQOS heated tobacco product with the U.S. Food and Drug Administration, which began its substantive review in May 2017. These heated tobacco products will be sold by Altria in U.S., if the FDA grants Philip Morris’ request. Such collaboration is encouraging as it will help the participating companies maintain market share amid declining volume and growing awareness against tobacco products.
May08, 2018
Target Price/Valuation
Provided below is a summary of valuation and ratings as compiled by Zacks Research Digest:
Rating DistributionPositive / 76.9%
Neutral / 23.1%
Negative / 0.0%
Avg. Target Price / $72.18
Highest Target Price / 84.00
Lowest Target Price / $62.00
No. of Analysts with Target Price/Total / 11/13
Risks to the achievement of target prices are the high sensitivity of cigarette volumes to taxes/prices, government regulations (the growing smoking restrictions may affect it further) and the increasing health awareness that is reducing tobacco consumption and leading to a switch to alternative tobacco products.
Recent Events
On Apr 26, 2018, Altria reported 1Q18 results wherein adjusted earnings of 95 cents per share surpassed the Zacks Consensus Estimate of 93 cents. Earnings also surged 30.1% year over year. Net revenues during the period inched up 0.4% year over year to $6.1 billion. Revenues, net of excise taxes improved 1.8% to $4.7 billion. The Zacks Consensus Estimate was $4.6 million.
On Mar 1, 2018 Altria announced a 6.1% hike to its quarterly cash dividend, taking it from 66 cents per share to 70 cents. The increased dividend is payable on Apr 10, 2018 to shareholders of record as of Mar 15.
Revenues
Provided below is a summary of revenue as compiled by Zacks Research Digest:
Total Revenue ($M) / 1Q17A / 4Q17A / 1Q18A / 2Q18E / 2017A / 2018E / 2019E / 2020EDigest High / $6,083.0 / $6,101.0 / $6,108.0 / $6,603.0 / $25,576.0 / $25,712.0↓ / $25,959.0↓ / $26,445.0
Digest Low / $6,083.0 / $6,101.0 / $6,108.0 / $6,462.0 / $25,576.0 / $25,548.0↓ / $25,652.0↓ / $26,445.0
Total Revenue / $6,083.0 / $6,101.0 / $6,108.0 / $6,532.5 / $25,576.0 / $25,630.0↓ / $25,805.5↓ / $26,445.0
Y-o-Y Growth / 0.3% / -2.4% / 0.4% / -2.0% / -0.7% / 0.2%↓ / 0.7%↓ / 2.5%
Q-o-Q Growth / -2.7% / -9.3% / 0.1% / 6.9%
The Zacks Digest average total revenues increased0.4% to $6,108million in 1Q18owing to higher revenues in the smokeless segment, largely offset by a drop in the smokeable category. Revenues, net of excise taxes improved 1.8% at $4,670 million.
Segment Revenue
Smokeable Products
Net revenues in the category dropped 0.8% year over year to $5,414 million, courtesy of lower volumes and increased promotional spending. These were mostly offset by higher pricing. Revenues net of excise taxes gained 0.4% year over year to $4,013 million. Total shipment volume in the category fell 4.1% from the prior-year quarter. Also, domestic cigarette shipment volumes dropped 4.2% year over year owing to lower cigarette industry volumes and decline in retail share. This was partially compensated by favorable trade inventory movements. The company has been witnessing declining cigarette volumes for a while due to stringent government regulations and increased consumer awareness regarding the negative impact of tobacco. Total cigarette retail share declined to 50.3%, representing a 0.7 percentage point slip. This was largely due to a 0.5 share point drop in Marlboro’s retail share owing to an increase in cigarette excise tax in California.
Smokeless Products
Net revenues in the segment rose 12.7% from the year-ago quarter’s figure to $525 million owing to voluntary recalls made in 2017 and improved pricing. Also, revenues net of excise taxes advanced 13.1% to $493 million in the quarter. Domestic shipment volumes in the category dipped 0.1% to 195.7 million units, mainly accountable to a decline in Skoal volumes and partly compensated by improved Copenhagen volumes. However, total smokeless products retail share gained 0.1 percentage points to 53.8% in the quarter.
Wine
Net revenues in the wine category increased 1.4% year over year to $142 million, driven by greater shipment volumes, partially countered by unfavorable mix. The segment’s revenues, net of excise taxes, inched up 0.7% to $137 million. Wine shipment volume improved 6.1% to 1.8 million cases.
Margins
Provided below is a summary of margins as compiled by Zacks Digest:
Margins / 1Q17A / 4Q17A / 1Q18A / 2Q18E / 2017A / 2018E / 2019E / 2020EGross Margin / 60.5% / 60.9% / 62.4% / 62.0% / 61.3% / 62.0% / 62.1% / 63.3%
Operating Margin / 50.5% / 50.4% / 49.8% / 51.2% / 51.4% / 50.2% / 53.2% / 55.9%
Pretax Income Margin / 47.8% / 50.7% / 50.2% / 50.8% / 50.3% / 50.3% / 54.4% / 57.2%
Net Income Margin / 30.7% / 36.9% / 38.5% / 38.9% / 33.4% / 38.5% / 41.6% / 43.7%
The Zacks Digest average gross profit improved 5.8% year over year to $2,913.8 millionand gross margin expanded190 bps to 62.4%. Operating companies’ income advanced 0.4% to $2,326.6 million. However,operating margin was down70 bps at 49.8%.
Segment Operating Income Details
Smokeable Products
Adjusted OCI declined2% to $1,995 million, while margins went down1.2 percentage points to 49.7%.
Smokeless Products
Adjusted OCI surged 27.3% to $340 million and margins expanded 7.8 percentage points to 69%.
Wine
Adjusted OCI dropped 19% to $17 million, as a result of employee bonuses, partially countered by higher revenues. Adjusted OCI margin also contracted 3 percentage point to 12.4%.
Consolidation of Manufacturing Facilities
In October 2016, Altria announced the consolidation of several of its manufacturing facilities to streamline operations and achieve greater efficiencies. During the first quarter of 2018, the company completed these plans. Such consolidation is expected to provide annualized cost savings of $50 million by 2018-end.
Earnings per Share
Provided below is a summary of EPS as compiled by Zacks Digest:
EPS / 1Q17A / 4Q17A / 1Q18A / 2Q18E / 2017A / 2018E / 2019E / 2020EDigest High / $0.73 / $0.91 / $0.95 / $1.04 / $3.40 / $4.03 / $4.46 / $4.93
Digest Low / $0.73 / $0.91 / $0.95 / $1.02 / $3.39 / $4.02 / $4.42 / $4.93
Digest Average / $0.73 / $0.91 / $0.95 / $1.03 / $3.39 / $4.03 / $4.44 / $4.93
Y-o-Y Growth / 0.7% / 35.0% / 30.3% / 20.7% / 11.9% / 18.6% / 10.3% / 11.0%
Q-o-Q Growth / 7.5% / 1.5% / 3.7% / 8.7%
The Zacks Digest average adjusted earnings of 95 cents per shareincreased almost 30% year over year. Bottom-linefigures gained from greater equity earnings from the company’s beer investments related to AB InBev, higher adjusted operating companies income (“OCI”) in the smokeless segments, lower outstanding shares and reduced adjusted tax rate. These positives were partially offset by reduced adjusted OCI in the smokeable unit.
Outlook
Management continues to expect adjusted earnings for 2018 in a range of $3.90-$4.03, up 15% to 19% year over year. This view excludes an expected charge of about 7 cents related to tax adjustments and certain special items.
Altria expects full-year 2018 adjusted effective tax rate to range 23-24%.
May08, 2018
Research AnalystLead Analyst
QCA / Vidya Nair
Vrishali Bagree
Sumit Singh
Copy Editor / Saswata Sinha
Content Ed. / Vrishali Bagree
No. of Broker reported/ Total No. of Brokers / 13/13
Reason for Update / Earnings