Altria (NYSE:MO) reported better than expected third quarter earnings Thursday, October 24, on both improved shipment volumes as well as pricing gains. Revenues net of excise taxes grew ~7% y-o-y, while adjusted earnings per share (EPS) grew ~11% over the same period. Having delivered adjusted net income of $1.81 per share during the first nine months of the year, the company reaffirmed its full year adjusted EPS guidance range of $2.36 to $2.41. 
Altria surprised estimates with a 1.2% growth in cigarette shipment volume during the quarter, which came primarily on one additional shipment day and inventory adjustments as cigarette consumption in the U.S. continued to decline. The company also posted strong results in the smokeless tobacco category, riding the growth in the overall market and popularity of its flagship brand, Copenhagen.
Our $38 price estimate for Altria will soon be updated to reflect the third quarter earnings announcement.
Pricing Remains The Key In Cigarettes
Although Altria reported growth in shipment volume for traditional cigarettes, it was primarily due to one extra shipping day and some adjustments in trade inventories during the quarter. Adjusting for these factors, the company's shipment volumes actually declined 3% y-o-y, in line with our estimates. Therefore, volume growth in the cigarettes category during the quarter was just an anomaly, as the longer-term trend of declining cigarette consumption in the U.S. remains intact. This is also apparent from the fact that Altria's shipment volume over the first nine months of the year declined more than 3.6%. However, the company was able to grow its revenue per cigarette by ~3% over the same period, while excise taxes per cigarette remained largely stable. 
Therefore, pricing remains the key growth driver for Altria and the tobacco industry in the U.S. at large. This is mainly because of the sticky nature of the demand for cigarettes due to their inherent addictive nature and consumer brand loyalties. Altria, the biggest player in the market, has been able to grow its adjusted operating income primarily on 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.
Smokeless Products Continue To Grow
Unlike cigarettes, smokeless tobacco consumption in the U.S. is expected to grow at ~5% CAGR over the forecast period, on growing popularity of these products among adults and relatively fewer regulatory concerns in the category.  Since these products are perceived to pose lower health risks, many consumers are also adopting them to quit smoking altogether. 
The smokeless products division contributes more than 20% to our price estimate for Altria. The company's flagship brands, Copenhagen and Skoal, together hold more than 50% of the market in this segment. The division continued its strong performance during the third quarter on growth in the overall market and higher retail share of Copenhagen. Revenues from the division grew 11% on both volume and pricing gains. Copenhagen holds ~30% retail share of the smokeless tobacco market in the U.S. and sold 15% more compared to the same period last year. We expect Altria to continue to lead the smokeless category with volume and value share gains through its popular brands. 
Amid the growing adoption of e-cigarettes in the U.S., Altria entered this category this year with the launch of the MarkTen brand in the test market of Indiana. During the third quarter earnings call, company officials mentioned that they were impressed with the initial performance of the brand and plan to expand its distribution to around 2,000 stores in Arizona by December. 
Although the market for e-cigarettes is very small for now - in terms of 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 a growing retail distribution are some key factors driving growth in the category. (See: Altria Could Add $5 Billion In Value By Selling E-Cigarettes)
Disclosure: No positions.