Altria Earnings Preview: Growth Hinges On Pricing Gains As Volumes Continue To Decline

Oct.23.13 | About: Altria Group, (MO)

Altria (NYSE:MO) is scheduled to announce its third quarter earnings on October 24. We will be closely watching the y-o-y variance in the company’s cigarette shipment volume during the quarter. In addition to health concerns, the growing popularity of e-cigarettes is accelerating the decline in traditional cigarettes sales in the U.S. (See: Altria Lights Up Earnings Despite Sliding Cigarette Volumes)

We expect the trend to exhibit itself in Altria’s third quarter earnings as well. The company is currently unable to tap the growing popularity of e-cigarettes as it has yet to launch its first e-cigarette brand nationwide in the U.S. It will therefore be interesting to see if Altria can deliver earnings growth through pricing measures on traditional cigarettes while growing or sustaining its leading volume market share.

Our $38 price estimate for Altria is about 5% above its current market price.

Cigarette Volumes To Decline

According to our estimates, Altria’s smokable products division that sells cigarettes and cigars makes up almost 70% of the company’s total value. The division operates in a very challenging regulatory environment marked by highly restrictive marketing rules and ever-increasing indirect taxes. Moreover, the growing use of smokeless tobacco products and electronic cigarettes due to increasing health consciousness among consumers is further aggravating the operating conditions of cigarette manufacturers. The consumption of traditional cigarettes in the U.S. has dropped by ~10% in volume since 2009. We expect the accelerating trend to pose a stiff challenge to the company in the long run.

Pricing Holds The Key

Despite all the challenges faced by the tobacco industry in the U.S., its dollar value has actually growing steadily over the years. This is because the Big Tobacco companies have been able to more than offset the decline in cigarette consumption through pricing measures. The sticky nature of the demand for cigarettes due to its inherent addictive nature and consumer brand loyalties has greatly helped the tobacco companies. Altria, the biggest player in the market, has been able to grow its adjusted operating income, primarily from the sale of cigarettes at more than 8% CAGR since 2009. Marlboro, the company’s flagship brand, commands more than 42% of the retail market for cigarettes in the U.S. and has held the leading position in the market for more than 30 years now. Such brand equity allows Altria to lead in pricing measures and increase its value share in the shrinking tobacco industry while maintaining decent volume share growth as well.

Noticing the recent acceleration in the decline of cigarette volumes, Altria reduced off-invoice promotional allowances on its Marlboro and L&M brands recently while raising list prices on the other brands. It will be interesting to see if the company is able to deliver earnings growth through improved revenue per cigarette during the quarter without sacrificing on its leading volume share.

Diversification To Help

Altria’s diversification into the smokeless tobacco products category insulates the company from shifting consumer preferences towards chewing tobacco and snuff. During the third quarter we expect the company to ride on the growing consumption of these products in the U.S. with its popular brands. Altria has been able to grow its revenue net of excise taxes from the division at ~7.5% CAGR, while the market for these products in the U.S. has grown at ~5% CAGR in volume since 2009. The Copenhagen and Skoal brands operated by the company hold more than 50% volume share of the retail market. According to our estimates, the smokeless products division contributes ~20% to the company’s total value.

Amid growing adoption of e-cigarettes in the U.S., Altria announced its entry into the burgeoning category this year. During the third quarter, the company launched the MarkTen e-cigarette brand through one of its subsidiaries, NuMark. We will be closely watching for any updates on the performance of MarkTen so far and the company’s plans to launch the product nationwide. (See: Altria Could Add $5 Billion In Value By Selling E-Cigarettes)

Although e-cigarettes is a very small market as of now – in terms of both volumes and revenue – it has been growing at a very rapid pace. At $1.5 billion in sales, the market for these vapor devices has tripled from around $500 million in 2012. Advertisements, increased awareness and trials, as well as growing retail distribution are some of the key factors driving growth in the category.

Disclosure: No positions.