Altria Group (NYSE:MO)
Presentation at Barclays Back-to-School Consumer Conference
September 3, 2013 10:30 a.m. ET
Howard Willard - CFO
Murray Garnick - Senior Vice President and Associate General Counsel, Altria Client Services
Jim Dillard - Senior Vice President, Regulatory Affairs, Altria Client Services
Good morning. It’s now my pleasure to welcome our next speaker, Howard Willard, the chief financial officer of Altria Group. Howard has been with the Altria since 1992, holding several leadership positions including executive vice president, strategy and business development.
The domestic tobacco category is in the process of evolving, of course, and Altria has taken a leadership role with its now Total Tobacco strategy. We look forward to hearing Howard’s insights as the landscape is being redefined by tighter regulatory oversight and rapid expansion into alternative tobacco products.
And with that, I’ll hand things over to Howard.
Thank you, Mike, and good morning everyone. Before we begin, please review the Safe Harbor statement in today’s presentation and the forward-looking and cautionary statement section in today’s press release for a description of the various factors that could cause our actual results to differ materially from projections included in today’s remarks. Reconciliations and further explanations of the non-GAAP financial measures discussed today are available on Altria.com.
Today we will focus on Altria’s formula for creating shareholder value, using our diverse business model and core strategies to achieve our long term EPS and dividend goals. Murray Garnick, senior vice president and associate general counsel for Altria Client Services, and Jim Dillard, senior vice president, regulatory affairs for Altria Client Services are also with me today. Following the presentation, we will all be available to answer your questions.
Our long term goals are to grow adjusted diluted EPS at an average annual rate of 7% to 9%, and to maintain a dividend payout ratio of approximately 80% of adjusted diluted EPS. These goals have guided us for the last several years, and we’re proud of the consistent results we’ve delivered.
Altria’s diverse business model, and our core strategies, help us achieve these goals. We’ll spend the balance of our presentation describing how our model and strategies help drive Altria’s performance.
Our diverse business model sets us apart from other U.S. tobacco companies. Our tobacco operating companies own the leading premium brands in the largest and most profitable domestic tobacco categories: cigarettes, smokeless tobacco, and machine-made large cigars.
With this total tobacco portfolio, and a focus on high-margin premium brands, Altria earned approximately 52% of the estimated combined profit pool in 2012. While the dynamics in these categories are different, our positions across them have allowed us to consistently grow income in an evolving industry.
We’re also very focused on continuing to develop new, innovative products for adult tobacco consumers. As the tobacco space continues to evolve and profitable new categories emerge, we intend to use our capabilities to develop leading premium brands.
Our growing alcohol assets provide diversification outside of U.S. tobacco and historically these assets have provided strong income growth. Our 27% economic interest in SABMiller allows us the participate in the estimated $32 billion global beer profit pool. The adjusted earnings from our SABMiller stake have grown from $552 million in 2008 to $976 million in 2012, a compounded annual growth rate of 15.3%.
Ste. Michelle Wine Estates is one of the fastest-growing premium wine companies in the United States. Ste. Michelle has grown adjusting operating company’s income from $73 million in 2009 to $104 million in 2012, a compounded annual growth rate of 12.5%.
In summary, our business model combines strong positions across U.S. tobacco, a large stake in a leading global beer producer, and a rapidly growing domestic wine business. Like most businesses, our companies operate in environments that can be challenging. However, our multiple sources of income generated from different industries and categories provide flexibility to manage through conditions that may impact one business more than another.
Additionally, our strong balance sheet gives us flexibility in managing our capital structure. Altogether, this business model provides a solid foundation for achieving our long term financial objectives.
Our core strategies focus Altria and our businesses on achieving consistent financial performance in the near term while creating sustainable growth opportunities for the future. Altria’s strategies are investing in strong premium brands, controlling costs, maintaining a strong balance sheet, and returning cash to shareholders, primarily through dividends.
As you know, investing in premium brands is an attractive strategy for a number of reasons. First, brands with strong brand equity typically support higher prices and higher margins. Second, premium brands generally have higher brand loyalty. As an example, over the last three years, during which we conducted brand equity studies, Marlboro had the highest brand equity and loyalty scores among major domestic cigarette brands.
Marlboro’s equity and loyalty have helped support strong adjusting operating companies income margins in our smokable products segment. Our companies work hard to build brand equity and loyalty to sustain income and margin growth over time.
In the smokable products segment, PM USA and Middleton’s strategy is to maximize income while maintaining modest share momentum on Marlboro and Black & Mild over time. Let’s take a closer look at how we’ve been investing in Marlboro, which is positioned as the cigarette men smoke for flavor.
PM USA has been investing in Marlboro since 1954. Behind these investments, the brand has delivered retail share growth for nearly 60 years. Today, Marlboro continues to be the largest and most profitable cigarette brand in the U.S.
Recently, PM USA has been investing in Marlboro’s architecture, which provides a broad platform to communicate with adult smokers while staying true to the brand’s essence. Each of Marlboro’s four flavor families expresses the brands positioning and values in its unique way, allowing Marlboro to expand the breadth of its equity building offerings.
Marlboro Red is the foundation upon which the architecture restaurants. The family established Marlboro as the most flavorful masculine cigarette brand. Marlboro Gold features the Marlboro man in a different moment, one of relaxation, that can only be found in the majestic serenity of the American West. Marlboro Green embodies Marlboro’s flavor heritage in a way that brings spontaneity to a classic campaign. And Marlboro Black is a bold, modern take on Marlboro, inviting adult smokers to navigate the unknown, where bold flavor is.
Marlboro Black, the newest flavor family, is a good example of how the architecture is strengthening the brand. In late 2011, PM USA introduced the Marlboro Black family with Marlboro Black box and Marlboro menthol black box. In September 2012, PM USA expanded distribution of Marlboro NXT to 27 states and then shipped the product nationwide in July 2013.
Marlboro NXT contains capsule technology in the filter that allows adult smokers to switch from nonmenthol to menthol taste. The Marlboro Black family is growing share and building a strong position, including with 21-29 year old smokers. We’re pleased with the results so far, and PM USA is working to maintain the momentum.
PM USA has also invested in the new Marlboro.com website. The website reinforces the architecture by efficiently building brand equity and executing promotions. Smokers 21 and older can use their computers or mobile devices to engage with their brand through articles, interviews, photographs, and videos available on the website. Since PM USA relaunched the site, both the number and duration of site visits have increased.
We’ve also invested in our premium machine-made large cigar brand, Black & Mild. Black & Mild is positioned as the best any day cigar adults enjoy for its smooth taste and pleasant aroma. Last year, Middleton introduced Black & Mild Jazz untipped cigarillos in 30 states, and in July of this year, it expanded distribution to the rest of the country. Also in February of this year, Middleton launched Black & Mild Jazz tipped cigarillos nationally.
The investments we’ve made in our smokable brands are delivering solid financial results. From 2008 through 2012, the smokable products segment grew revenues net of excise taxes per thousand units at a compounded annual rate of 5.5%, increased adjusting operating companies income at a compounded annual rate of 4.7% to $6.3 billion, and expanded its adjusting operating companies income margins of 7.4 percentage points to 41.2%.
During the same period, PM USA grew Marlboro’s retail share by an average of approximately two tenths of a share point per year, to 43.6%. Comparing the first half of 2013 with the first half of 2012, the smokable products segment grew revenue net of excise taxes per thousand units by 4.6%, increased adjusted operating companies income by 1.4% to $3.1 billion, and expanded adjusted operating companies income margins by 1.3 percentage points to 42.5%. During this same period, PM USA grew Marlboro’s retail share by one tenth of a share point to 43.6%.
In our smokeless product segment, we are investing in the two leading premium moist smokeless tobacco brands, Copenhagen and Skoal. Our smokeless product segment has been growing volume and delivering storage adjusted operating companies income and margin growth. In the smokeless product segment, US SPC’s strategy is to increase income by growing its volume at or ahead of the category growth rate while maintaining modest share momentum on Copenhagen and Skoal combined.
Copenhagen has provided adult dippers moist smokeless tobacco satisfaction since 1822. Copenhagen’s strong equity is grounded in its core values of masculinity, heritage, authenticity, and tradition. Copenhagen has a long history as the leading brand in the natural segment. Over the last few years, the brand has focused on profitably expanding Copenhagen’s forms and taste profiles to appeal to more adult dippers.
In late 2009, the brand launched Copenhagen Long Cut Wintergreen, entering the largest and fastest-growing segment of the category. Copenhagen Long Cut Wintergreen has grown retail share for the last 11 quarters.
This month, US SPC is reintroducing one of its seasonal offerings, Copenhagen Black. Copenhagen Black is a small batch, barrel-aged product that reinforces the brand’s craftsmanship. This product will be available nationwide for a limited time.
Skoal is the contemporary MSP brand that provides a smooth smokeless tobacco experience. Skoal’s products offer great taste in forms that are easy to manage. Historically, Skoal has been the innovation leader of the smokeless category, expanding the forms and blends of MSP.
Today, adult dippers can find Skoal in every major MSP form and in most varieties. Skoal has evolved its traditional product portfolio as adult dipper taste preferences have changed. Adult dippers can choose between the big, smooth flavor of Skoal Extra products and the balanced, smooth taste of Skoal Classic products.
Skoal also has updated the brand’s packaging and retail look to better reflect the brand’s contemporary premium qualities and to better communicate the attributes of Skoal Extra and Skoal Classic.
US SPC’s investments in Copenhagen and Skoal have been driving growth in the smokeless products segment. From 2009, the year Altria acquired USP, through 2012, the smokeless products segment grew Copenhagen and Skoal’s combined volume at a compounded annual rate of 7.6%, great Copenhagen and Skoal’s combined retail share by an average of approximately one share point per year to 50.4%, increased adjusted operating companies income at a compounded annual rate of 14.9% to $959 million, and expanded adjusted operating companies income margins by 11.3 percentage points to 60.8%.
Comparing the first half of 2013 with the first half of 2012, the smokeless products segment grew Copenhagen and Skoal’s combined volume by 5.4%, grew Copenhagen and Skoal’s combined retail share by 0.6 of a share point to 50.7%, increased adjusted operating companies income by 9.1% to $492 million, and expanded adjusted operating companies income margins by 2.4 percentage points to 62.4%.
So far, I’ve discussed our investments in cigarettes, machine-made large cigars, and smokeless tobacco. As we recently highlighted in our investor day, we formed Nu Mark to focus on developing new, innovative tobacco products for adult tobacco consumers. Nu Mark’s ultimate goal is to create superior premium products that exceed adult tobacco consumers’ expectations and provide opportunities for sustainable income growth.
Now I’d like to provide you with an update on Nu Mark’s progress with e-cigarettes. According to our research, awareness of e-cigarettes is high and growing. The category is growing rapidly, but off a small base. We estimate that consumer expenditures for e-cigarettes will reach approximately $1 billion in 2013.
According to our data, increased retail sales are driving category growth while internet sales as a percentage of total category sales are shrinking. Last month, Nu Mark introduced MarkTen e-cigarettes into a leading market in Indiana. Nu Mark is executing plans to test the brand’s value equation, including product, packaging, price, promotion, and placement.
After working with Altria’s market research and product development teams to understand adult smoker and vaporer preferences, Nu Mark has developed what we believe is a superior product. MarkTen e-cigarettes offer adults smokers and vaporers a familiar draw with an appealing taste. Its unique four-draw technology is designed to give adult vaporers a more consistent experience, puff to puff and day to day. Nu Mark believes its technology provides an experience that closely resembles the draw of a traditional cigarette.
Unlike many other e-cigarettes, MarkTen e-cigarettes can be used either as a disposable or rechargeable device. Adult vaporers who are looking for a disposable can purchase a single unit that’s ready for use right out of the box. To use the product as a rechargeable, adult vaporers may purchase replacement cartridges and an accessory kit that includes charging devices.
The product is available in two varieties: classic and menthol. Retailers are selling the device for $9 to $9.50 and a pack of four replacement cartridges for approximately $13. Nu Mark, through Altria Group Distribution Company, is continuing to sell in the product at wholesale and retail. As of the third week of August, retail stores selling approximately 85% of cigarette volume in Indiana have signed up to sell MarkTen e-cigarettes.
At retail, Nu Mark is using premium point of sale materials to create brand awareness and is prominently featuring MarkTen e-cigarettes in fixtures and displays behind the counter. While it’s early, the initial feedback from the trade is very positive.
Nu Mark is also building brand awareness and equity among adult smokers and vaporers. The brand’s marketing campaign is centered on the tagline “Remarkable.” Nu Mark is sending direct mail to introduce the campaign, communicate the brand’s unique attributes, and provide trial generating offers.
The company also launched a print advertising campaign in magazines like Rolling Stone, Vogue, and GQ, and in August began hosting promotions in adult only facilities at concerts and sporting events.
This month, MarkTen plans to launch MarkTen.com for adult smokers and vaporers 21 and older. MarkTen.com will include webisodes highlighting key product features and reinforcing the remarkable campaign. Now let’s watch one of the brand’s webisodes. [Webisode plays.]
We believe Nu Mark is off to a good start with MarkTen e-cigarettes, and we’re learning how to compete effectively in this emerging category. Introducing superior products, achieving broad retail distribution, building brand equity, and navigating a changing regulatory environment will all be important, and Nu Mark has significant capabilities with regard to all of them. While today the category is quite small compared to cigarettes, Nu Mark will remain focused on addressing this growing opportunity.
Altria’s second strategy is controlling costs. Cost management is particularly important in the cigarette business, where volumes are declining. PM USA has focused on reducing its fixed infrastructure costs while efficiently managing its variable costs per pack. Over the past five years, Altria has executed two productivity programs across its companies. The first program ran from 2007 through the third quarter of 2011 and reduced costs by $1.5 billion.
After completing this program, we launched a second cost-reduction initiative to achieve an additional $400 million in annualized cost savings versus previously planned spending by the end of 2013.
Behind these programs and other efforts, we’ve held our controllable cost per thousand in the smokable products segment very close to flat, from 2008 through 2012. Controlling costs remains an important strategy and part of our culture.
Our third strategy is maintaining a strong balance sheet. A strong balance sheet supports our investment grade credit rating and our ability to return cash to shareholders. Maintaining our investment grade credit rating is important because it allows us to competitively access the capital markets for our short and long term cash needs.
For example, we may access the commercial paper market to cover short term cash needs in months immediately preceding and following MSA tax and dividend payments that occur each April. Our commercial paper issuances are backstopped by our revolver, which we just extended through 2018.
Our strong balance sheet also has allowed us to refinance high coupon debt and replace it with new, lower cost debt. As a result of these and other actions, we’ve decreased our weighted average coupon rate from 9.1% at the end of 2009 to 7% as of June 30, 2013.
From now through the end of the first quarter of 2014, approximately $2 billion of debt will come due, with associated annual interest payments of approximately $160 million. Our decision to refinance or retire this debt as it comes due depends upon conditions in the capital markets, interest rates, business needs, and other factors. Our debt-to-equity ratio of approximately 1.8:1 as of June 30, 2013 is well within our credit agreement debt covenants of not more than 3:1.
Altria’s economic interest in SABMiller also strengthens our balance sheet, contributes equity earnings and cash flow, and provides a potential source of liquidity. The market value of Altria’s interest has increased nicely from $3.4 billion in July of 2002 to approximately $21.1 billion as of July 31, 2013. We regularly evaluate our economic interest in SABMiller and currently believe maintaining the investment is in the best interest of our shareholders.
Altria’s balance sheet also supports our fourth strategy, returning cash to shareholders, primarily through dividends. Our track record is strong. Since the PMI spinoff in early 2008, through August 31, 2013, Altria has paid shareholders $16.2 billion in dividends. Our 2012 dividend payout ratio of approximately 80% of adjusted diluted EPS is the highest in the S&P’s food, beverage, and tobacco index, and was among the highest in the S&P 500.
Last month, our board of directors increased Altria’s dividend by 9.1% to an annualized rate of $1.92 per share. Since the PMI spinoff, we’ve increased our dividend seven times at a compounded annual growth rate of 8.8%. Our dividend yield of 5.6% as of August 23 exceeds the 2.8% yield of 10-year U.S. Treasuries and the 2.1% yield of the S&P 500.
Though future dividend payments remain subject to the board’s discretion, a strong and growing dividend is an important part of why we believe that Altria is an attractive investment in any environment.
We also repurchase stock when we conclude that it is the best use of cash to maximize shareholder value. Since the PMI spinoff, through June 30, 2013, Altria has repurchased approximately $3.8 billion of shares. Last month our board authorized the expansion of our current share repurchase program from $300 million to $1 billion.
Through June 30, 2013, we have repurchased approximately $135 million under the expanded program, which we expect to complete by the end of the third quarter of 2014. The timing of share repurchases depends up on marketplace conditions and other factors.
Before concluding, there are two areas always of interest and importance: litigation and regulation. Regarding tobacco and health litigation, we have had success managing the claims brought against our companies, although significant challenges remain. We have defended these claims vigorously for decades and intend to continue to do so. A comprehensive discussion of the tobacco-related litigation is available in our latest Form 10-Q.
Turning to FDA regulation, in July FDA released its preliminary scientific report on the use of menthol in cigarettes and invited public comment. Previously, PM USA provided FDA with detailed presentations and comprehensive submissions on this topic. Our assessment of the science and evidence has been, and continues to be, grounded in a well-established, science-based approach.
In response to FDA’s recent releases, we will communicate to FDA our perspective on relevant menthol-related subjects including our science-based perspective on FDA’s preliminary science report and the peer review analysis, the report submitted to FDA by the Tobacco Products Scientific Advisory Committee, and important considerations related to unintended consequences.
We continue to believe that menthol added to cigarettes does not increase the inherent health risks of cigarettes. Based on available evidence, menthol does not play a unique role in smoking initiation, dependence, or cessation, and taken as a whole, menthol cigarettes do not affect population harm differently than non-menthol cigarettes.
As we’ve said previously, any future action taken by FDA to regulate the sale or distribution of menthol cigarettes, or establish a tobacco product standard, will require rule making including public notice and the opportunity for comment. FDA is required to consider public comments as part of the regulatory process.
To sum up, Altria has delivered consistent financial performance over time by using our diverse business model and our core strategies to achieve our long term EPS and dividend objectives. With this formula, we’ve produced a strong track record of creating value for our shareholders. Altria has delivered adjusted diluted EPS growth in excess of 7% in four out of the last five years, and we’re one of only a handful of domestic companies in the S&P food, beverage, and tobacco index to do so.
From 2007 through 2012, we grew our adjusted diluted EPS at a compounded annual rate of 7.9%, as compared with the S&P 500’s operating EPS growth of 3.2%, which excludes corporate and unusual items in a manner similar to our adjusted diluted EPS measure.
From 2008 through 2012, we’ve increased our dividend payout ratio, while the payout ratio of the S&P 500 has fallen. Over this same period, our average payout ratio has been one of the highest among large U.S. consumer staples companies.
Our adjusted EPS growth, together with our large and growing dividend, has produced excellent total returns to shareholders. From the end of 2007 through July 31, 2013, Altria’s total shareholder return was 111%, outperforming the S&P food, beverage, and tobacco index’s return of 82% and the S&P 500’s return of 30% for the same period.
In conclusion, we believe that the business model, core strategies, and long term goals that helped produce these results position us to deliver strong results in the future. Altria reaffirms that it expects 2013 full year adjusted diluted EPS to increase by 7% to 9% to a range of $2.36 to $2.41 from an adjusted diluted base of $2.21 per share in 2012.
Thanks for your attention. Now we’ll take your questions.
Unidentified Audience Member
The general expectation is that the U.S. cigarette category will decline at or above a 4% rate this year and next year. I’m wondering if you could characterize the relative impact of a couple of factors on that, worse than historic rate of decline, specifically pricing, regulation, new products such as e-vapor cigarettes, and macroeconomics. And then on the e-vapor cigarette side, you indicated you expect to be a $1 billion category at the end of 2013. Could you elaborate on your thought process about how large that category might be in a few years and where you envision MarkTen and a broader Altria portfolio in terms of market share or relative position?
Sure. Well, I think if you look historically at the traditional cigarette volumes, they’ve been declining at a 3% to 4% rate over the last several years. Last year it was on the low end of that range. This year, on a year to date basis, it’s down about 4% based on our estimates. So we see it performing relatively consistent with the past.
I think the big question has been, “Well, what’s the impact of e-cigarettes on that decline rate?” And I think given that it is still consistent with its historical decline rate, I think you have to consider the fact that the decline is made up of a secular decline rate that essentially takes into account changes in traditional smokers’ behavior, reductions in cigarettes per day, changes in the incidence rate, and also movement to other categories. In the past, some of those categories were smokeless tobacco and cigars. This year, certainly e-cigarettes have joined that as part of the driver of the secular decline rate.
And then of course the other driver is changes in price, and we’ve seen a pretty consistent price elasticity impact of -0.3%. So I think we view that there’s no indication from this year that the category decline rate has kind of broken out of its historical decline rate. And we’ll see what happens through the rest of the year.
I think with regard to what happens in the future with regard to e-cigarettes, I think there’s quite a few variables that are going to drive that that we don’t know how they’re going to turn out yet. Certainly the category has grown quite rapidly to get to this billion dollar rate, but I think some of the key drivers going forward are going to be what happens with regulation. FDA has said that they plan to deem the category into their regulatory framework here in the near future. I think that’s going to have a big impact.
And then I think what happens with product development is also going to have a big impact. You saw that the awareness levels are quite high, but usage is relatively low compared to that awareness. And I think there’s an awful lot of smokers that when they try e-cigarettes are disappointed and don’t continue using them. And I think the real question is can product development provide potential e-cigarette smokers with a better experience over time.
And I think that how those factors play out is going to have a lot to do with whether or not the category continues to grow at a relatively fast rate or ends up stalling out at a much smaller level.
Unidentified Audience Member
To elaborate on that, do you have any data on how many vaporers you’re getting versus smokers, and any repurchase data? Do you have any input on that?
I would say certainly with regard to our MarkTen product, it’s just entered the market, so it’s too soon to tell on that. And I would say that with regard to the market overall, while we are in the process of collecting that data, there’s nothing we’re in a position to share beyond what was in the presentation.
Unidentified Audience Member
Maybe if you could go through a little bit more color in terms of the actions of the FDA. And just one with respect to the deeming regulation on e-vapor cigarettes, any insight into what you think might happen with internet sales in terms of potential regulation? And then how would you characterize what you’ve reflected on with your comments on menthol, and directionally how you think that’s progressing.
I’m going to hand that right over to Jim Dillard.
Let me start with the deeming regulation, because I think that it’s pretty typical that anybody in the room, and us included, would love to know exactly what the FDA is thinking and where they’re going to move. And I think what we know to this point is that they have considered the fact that there are multicategories of products. It isn’t as simple as just deeming an e-cigarette in one regulation, cigars and pipe tobacco.
So I think part of the reason that we’ve seen four extensions in terms of them actually publishing a deeming regulation is that they’re seeing that it’s quite complex to take multiple different categories and try to apply the Family Smoking Prevention and Tobacco Control Act uniformly across those categories.
So now that they have said that October is their date that they are shooting for, I think at this point we tend to try to believe the fact that they’re working hard on the deeming regulation. We certainly know from a couple of factors that I think have influenced the agency at this point, which is Mitch Zeller came on board, said he was going to focus on deeming regulation, substantial equivalence, and publishing the menthol report.
And so publishing the menthol report has happened, we’ve started to see a few minor numbers, 10 substantial equivalence decisions out of 4,000 submissions. And so what I would say is that we think the agency probably under Mr. Zeller is making some progress on deeming regulation as well. So to be able to predict today, that’s probably beyond the scope of my capability to say whether that will be October, but I think that they’re making progress.
On the menthol side, I think Howard sort of outlined where our company position has been, and the fact that it’s a long proposition, this analysis of menthol. And I think the way we think about it is, in addition to the science report that’s published, the agency clearly in this proposed rule-making has asked for comments from stakeholders on not only the science, but 15 related questions to help shape their thinking.
On top of that, they’re guided by the statute itself, which, if they are going to take any regulation, they have to consider unintended consequences and countervailing effects, which is another big process within the menthol analysis, and we think that that part of the process has yet to begin.
So we see this as a very long term perspective on menthol, and I would expect that the agency will take the stakeholders comments, they would analyze them completely, and certainly we intend to fully respond to both the science as well as the questions. So I think we’re still a ways off before we see any proposal by the agency on regulatory activity.
Thank you very much. I think we’re going to stop here and proceed to the breakout room.
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