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The tobacco industry is experiencing difficult times due to certain advertising and promotional restrictions promulgated by the FDA, high tax impositions as well as the growing number of consumer health advocates promoting healthy activities. Moreover, the industry is highly competitive and has reached the saturation point.

According to Forbes, the present-day per capita consumption of cigarettes in the USA has increased in lesser proportion to the increase in the population since 1975. The numbers show that, in absolute terms, cigarette consumption has decreased by half from the all-time high consumption of 1975.

These circumstances have affected the financial stability of many US tobacco manufacturers. Due to its effective strategies and diverse business model, Altria Group Inc. (MO), the largest manufacturer of tobacco products in the US, is still showing strong results. The company's adjusted per share earnings in the last reported quarter increased by 12.1%YoY.

Let us examine to what extent the diverse business model and new strategies will benefit the company in the long run.

First to Third Quarter Results of 2013

The company operates in three business segments: smokable products, smokeless products and wine. This expanded portfolio reduces the company's dependency on only cigarettes and cigars.

During the first nine months of 2013, the smokable segment's revenues declined 1% YoY primarily due to lower shipment volume. Sales in both cigarettes and cigars experienced a decline. On the other hand, the revenues in the smokeless products increased 7.2% due to higher shipment volume and higher pricing. The revenue in the wine segment also grew by 7.9% as a result of higher shipment volume, improved premium pricing, and higher pricing compared to the first nine months of 2012.

A higher demand for smokeless and wine products offset the effects of lower demand for smokable products and ultimately improved the total net revenues by 10 basis points in the first nine months of 2013, on a yearly basis.

Altria is implementing a cost reduction program effective from the first quarter 2012.The program is projected to deliver $400 million in annualized savings by the end of 2013.

As a result of this program the company's gross profit in the first three quarters of 2013 increased by 12.1% compared to reports of the previous year. The company's operating margin increased by 4.32% while the net margin increased by 5.25% to 22% from 16.75% in the first three quarters of 2013. The adjusted per share earnings increased by 9% in the first nine months of 2013.

The chart below gives a brief overview of Altria's balance sheet and operating cash flow. The company's liquidity position has improved considerably as its current ratio has increased by more than 18%. Its debt-to-equity ratio increased in 2013 but the improvement in the interest coverage ratio shows that the company is now in a better position able to pay its interest and other debt related expenses. Altria's cash flow generation is also strong. The operating cash flow in the third quarter of 2013 increased by 13.5% which eventually improved the company's ability to cover the total debt expenses through cash flows since its operating cash flow-to-debt ratio has increased on a yearly basis.

Dividend Policy

Altria has an excellent record of paying dividends. The chart below shows that from 2008 to 2012 Altria has been paying significantly higher dividends to its investors than the S&P 500 index companies' averages. In August 2013, the board of directors increased the regular quarterly dividends by 9.1% to $0.48 per common share. As of October 21, 2013 the company's annualized dividend yield was 5.3%.

(click to enlarge)

Source: Investor Presentation

Management expects to continue paying dividends by maintaining a dividend payout ratio target of approximately 80% of the adjusted diluted EPS.

Future Outlook

It is anticipated that in mature markets the demand for smokable products i.e. traditional cigarettes and cigars will further decline in the developed markets. However, it is expected that sales will continue to rise in the developing countries despite increasing pressure from anti-smoking campaigns, legislations, taxes and the rise in health concerns. The global market is forecasted to reach $910 billion by the end of 2018.

The smokeless tobacco segment is currently considered to be the fastest growing segment in the US as the demand for e-cigarettes continues to grow mainly due to tax exemption on these cigarettes. There is also a probability that the FDA will approve e-cigarettes. Being one of the largest players in both the smokable and smokeless tobaccos markets Altria will benefit from these trends.

The condition of the global supply of the wine industry appears to be improving. The market performance is forecasted to accelerate over the next four years. The demand for wine is also expected to shift to from the current largest wine consumers such as US, Italy, Brazil to the markets of developing countries. Asia will account for more than 50% of wine consumption up until 2015. The demand for wine in America is expected to continue growing at a CAGR 10% from 2011 to 2015. Overall, the industry is anticipated to grow at a CAGR of 3.4% from 2012 to 2017 driving the market to a value of approximately $318 billion. This positive outlook will improve the earnings of Altria's wine segment in both the domestic and international markets.

The company's management expects the full year diluted EPS to be in the range of $2.57 to $2.62 or 24.76% to 27.2%.

Conclusion

The company's diversified business has protected it from concentration risk and maintained its stability despite the poor demand for tobacco products. The margins, balance sheet and operating cash flow also reflect the company's stability. The future demand outlook, especially for e-cigarettes,is expected to further improve Altria's financial health.

Since the company has an impressive record of dividend payout and will continues to improve its financial stability in the future I would recommend buying the company's stock.

Source: Altria - Diversified Portfolio Creating Brighter Prospects