Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Altria Group Inc (MO)

Q3 2006 Earnings Call

October 25, 2006 2:00 pm ET

Executives:

Louis Carey Camilleri – Chairman and CEO, Altria Group, Inc

Dinyar S. Devitre – Senior VP and CFO, Altria Group, Inc.

Nicholas Rolli – VP of IR and financial communications

Analysts:

Christine Farkas – Merrill Lynch

Bonnie Herzog – Citigroup

David Adelman – Morgan Stanley / Dean Witter

Judy Hong – Goldman Sachs

Christopher Growe – A. G. Edwards & Sons, Inc.

Philip Ferguson – Credit Suisse

Erik Bloomquist – JP Morgan

Ann Gurkin – Davenport & Co. of Virginia, Inc.

Operator

Good afternoon and welcome to Altria Group’s 3Q 2006 earnings conference call. Today’s call is scheduled to last about one hour including remarks by Altria's management and a Q & A session. (Operator Instructions). Media representatives on the call today will also be able to ask questions following the conclusion of questions from the investment community. I'd like to turn the call over to Nicholas Rolli, VP of IR and financial communications for Altria. Please go ahead sir.

Nicholas Rolli

Good afternoon and thank you for joining us on the call today. For those of you listening via the audio webcast, we are providing summary slides of 3Q results of Philip Morris USA, PM International and Kraft Foods. Kraft Foods reported its 3Q 2006 results on Monday and hosted a separate webcast. Since the food business was covered in detail on that webcast the discussion of Kraft will be limited on this call.

Our remarks contain forward looking statements and projections of future results, and I direct your attention to the Safe Harbor statement at the end of our news release for review of various factors that could cause actual results to differ materially from projections.

Finally, Louis Camilleri, Altria's CEO is joining us on this call. Following remarks by Dinyar Devitre, our Senior VP and CFO, both will be available to take your questions on today's earnings and board announcements. And as you know, both releases are available on our website at www.altria.com. And now it’s my pleasure to introduce Dinny.

Dinyar Devitre

Thank you Nick, and good afternoon everyone. Today the Altria board of directors issued a statement regarding the envisaged Kraft's spin-off. The announcement provides clarity on the board's future intentions. I would also like to mention yesterday's upgrade by Moody's investor service of the long-term senior unsecured debt rating of Altria Group, Inc to BAA1 from BAA2, and as affirmation of the company's short term commercial paper rating of PRIME 2. We are very pleased with this favorable development.

Turning to 3Q earnings, Altria's diluted EPS adjusted for the one-time items shown on page 2 of our news release, we are up 1.5% to $1.39 and we remain on target to meet our earnings target for the full year. We project 2006 full year diluted EPS from continuing operations in a range of $5.48 to $5.53 vs. our previously disclosed range of $5.40 to $5.50.

The company's revised forecast includes two new items, which together reflect a net increase to our EPS forecast of $0.04. Kraft’s gain on the Minute Rice sale of approximately $0.07 and Kraft’s gain on the redemption of its interest in United Biscuits of approximately $0.06 vs. our previous guidance of $0.09. It does not include the impact of any potential future acquisitions or divestitures.

Turning to tobacco, Philip Morris USA continued to deliver strong share performance, driven by Marlboro. Operating companies income rose 5.7% to $1.3 billion primarily driven by lower wholesale promotional allowance rates and a favorable comparison with items in 3Q 2005. These were partially offset by lower volume and spending of approximately $24 million for various ballot initiatives mainly in California. Excluding all one-time items OCI was up 1.3%.

Cigarette shipment volume of 47.6 billion units was down 0.6% from the previous year, reflecting changes in wholesale and retail trade inventory levels and the timing of 4th July trade purchases and one less shipping day vs. the year ago period. PM USA estimates that shipment volume declined approximately 2% in the 3Q and was down approximately 1.5% for the first 9 months of 2006.

In the quarter, retail share advanced 0.3 points vs. a year ago, to 50.4% behind the continued strength of Marlboro. Marlboro achieved a 40.6% market share, up 0.5% vs. prior quarter. Its price gap with the lowest priced brand remained stable at approximately 45%. PM USA share of the premium category declined 0.1 point, to 62.1%, reflecting losses in PM USA's non-focus premium brand. The discount category declined 0.7 points to 25.7% in the 3Q, while the deep discount segment was down 0.2 points to 11.7%. PM USA's share of the discount category was up 0.1 point to 16.3%.

For the full year 2006, PM USA is on track to deliver moderate retail share growth and operating companies income growth in the mid single digit range.

Turning to our international tobacco business, PMI's 3Q results were adversely impacted by the anticipated trade inventory depletion in Japan, following the July 2006 price increases and ongoing challenges in Spain.

Operating companies’ income was down 3.8% to $2.1 billion and down 2.3% excluding asset impairment and exit costs. The decline was due primarily to unfavorable volume mix in Japan and lower pricing in Spain, partially offset by higher pricing elsewhere in PMI.

Spain and Japan together contributed approximately 8 percentage points to the decline in 3Q OCI. Cigarette shipment volume declined 0.5% to 215.9 billion units, due mainly to declines in Spain, Japan, Turkey and Romania, largely offset by gains in Italy, Poland, Russia, Ukraine, Indonesia and Argentina.

In Spain the total market was down 7.9% due largely to an unfavorable comparison with the prior quarter, which benefited from trade purchases as a result of an anticipated industry price increase that did not occur. PMI shipments were down 12.4% and market share declined 3.1 points to 32.2% reflecting losses on L&M and Chesterfield. Marlboro remains resilient with share down only 0.2 points.

However sequentially, PMI's market share in Spain was up 0.6 points vs. the 2Q 2006 and share in the 4Q is also projected to be up. The key challenge in Spain is that PMI's profit margin has declined and recovery of this loss margin will take some time. We remain cautiously optimistic that the long awaited minimum excise tax increase will be instituted in the coming months.

In Turkey, PMI shipments were down and market share declined 0.7 point to 41.9% due mainly to low price Bond Street, partially offset by gains of high margins brands Parliament and Muratti. Profitability was nevertheless significantly higher.

Turning to Japan, PMI shipments were down 1.8 billion units or 10% due mainly to a 23% total industry decline, partially offset by the favorable timing of shipments. PMI's in-market sales were down approximately 4.2 billion units or 22.5%, although share was up 0.1 points to 25% driven by Marlboro. PMI expects shipments to be up in the 4Q in Japan.

Many major PMI markets performed strongly in the 3Q.

In Italy, the total cigarette market grew 0.7% and PMI shipments were also up. Market share increased 1.2 points to 54.1% due mainly to Marlboro which grew 0.5 points to 23%. Share growth was also recorded by Diana.

In Germany, total tobacco consumption declined 9.5%, but adjusted for one less selling day in the quarter this year, was down 8.1% due primarily to decline of tobacco portions. PMI share of total tobacco consumption rose 2.8 points to 31.5% in the 3Q. The total cigarette market in Germany declined 1.8% but excluding one less selling day it was flat, the first time this has happened in approximately 17 quarters. PMI shipments were down 2.2% and cigarette share declined 0.1 point to 36.5%.

Marlboro share was down 2.4 points to 27.2% reflecting continued consumer down trading to the value segment. This share erosion was largely offset by gains of L&M, which grew 2.1 points to 2.9% in the 3Q. As you are aware, tobacco portions in Germany are nearly out of the market and initial indications are that most portion smokers are moving to fine cut with the remainder, according to published surveys by the German's Cigarette manufacturers association, purchasing non-domestic product and to a lesser extent, domestically manufactured cigarettes.

In Poland, PMI shipments were up 7.4%. Market share advance 3.5 points to 40.6% behind the strong performance of Marlboro and L&M. Share for Marlboro grew 0.5 points to 8.5% while L&M was up 6 points to 14.4% in the 3Q.

In Russia, shipments were up 3.3% driven by Marlboro, Muratti and Parliament and aided by favorable timing. Market share was down 0.5 points to 26.5%, but the loss was primarily due to low priced brands and L&M. Importantly, Russian consumers continued to trade up to the higher price segments where PMI is well represented with diverse portfolio led by Marlboro, Parliament, Virigina Slims, Muratti and Chesterfield.

In Ukraine, shipments rose 8.8% and market share grew1.2 points to 33.4% fueled by consumer up trading to international brands. Marlboro gained 0.7 points in the 3Q, while Parliament and Chesterfield also continued to perform strongly.

In Indonesia the 3Q marks the first comparable results since the acquisition in May 2005 and the performance has been terrific on both the top and bottom-line. PMI shipments grew 9.1% and market share rose an impressive 1.5 points to 28.2%. PMI's strong brands, including A Hijau, A Mild, Dji Sam Soe and Marlboro are well positioned for future growth.

In Argentina the total market was up 7.8% and PMI shipments grew 18.2%. Market share advanced 5.9 points to 66.9% reflecting continued growth of Philip Morris brands.

To sum up on PMI, for the 4Q2006 PMI is expecting to deliver strong YoY volume and income growth. PMI projects full year 2006 total volume growth to approximately 3 to 4% with about organic volume essentially flat. Operating companies income is forecasted to increase in the mid single digit range, on a constant currency basis.

Turning to our Food business, Kraft reported its results on Monday so let me give you a few brief financial highlights. Net revenues were up 2.3% to $8.2 billion driven by good performance in North America and favorable currency of $125 million. Ongoing volume declined 1.9% due primarily to product item pruning and discontinuation of select product lines. Operating income increased 18.2% to $1.4 billion. Excluding asset impairment, exit and implementation costs and gains and losses on sales of businesses operating income increased 5.6% and operating income margin increased to 15.2% from 14.8%. That concludes my prepared remarks and now we'll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Chiristine Farkas from Merrill Lynch.

Chiristine Farkas - Merrill Lynch

Thank you very much and good afternoon. A question for Louis if I might, just based on the board announcements and I looked at the Jan 31st can you comment a little bit about what greater clarity you would hope to have by Jan 31st in making that decision?

Louis Camilleri

I'll try to elaborate to the extent I can Christine. I think today's announcements clearly shows to the world that the board is comfortable with the (implied?) litigation environment and is therefore prepared to move forward. The obvious question which is your question then why Jan 31st? Frankly it’s a simple answer to that, the board as you know has always acted in an orderly and very deliberate manner and it is going to go through a deliberate formal process of crossing the t's and dotting the i's.

And I think also in addition to that, the timetable does coincide with Irene Rosenfeld herself, the Kraft CEO's announcement of Kraft's new profitable growth plan. I'm sure that’s very important, given the concerns that have existed about a potential overhanging issue.

So it’s really two things Christine, the whole formal process as well as the timetable coinciding with Irene's timetable.

Chiristine Farkas - Merrill Lynch

Terrific, thanks for that. If I could follow up with Dinny on your guidance for the year, I'm sure you're clear about the $0.04. Coming into your guidance there seems to be an additional $0.04 in the bottom end of your revised guidance. Can you just elaborate where that would be coming from?

Dinyar Devitre

Well, a number of factors. A little bit on tax, a little bit on currency and basically what we are doing is narrowing the range and giving the upper side of the range.

Chiristine Farkas - Merrill Lynch

Ok, great that’s helpful and the last question I have is on Japan, you've indicated that in the 4Q the expectation is that some of that de-loading would reverse based on what you are seeing in the market are you comfortable that we are actually through the inventory de-loading this quarter and that will in fact reverse in the 4Q or is it sparsely through the 4Q?

Dinyar Devitre

Yeah I think we are pretty confident that most of it has come out maybe a little more was to come out in October but most of it is out.

Louis Camilleri

If I could get out a point as well there are a number of new products slated through the 4Q in Japan (inaudible).

Chiristine Farkas - Merrill Lynch

Thank you very much.

Operator

Your next question is from Bonnie Herzon from Citigroup.

Bonnie Herzon - Citigroup

Good afternoon everyone. Hi guess I wanted to start off with just a question on the discussion today by the board which seemed quite positive you just said Louis so thank you for that. When you wrote in the press release that you intend to finalize this vision, should we all assume that this was discussed at great length either today or the last month or two and there are just a few open items and I don’t know if you can go into that you said they act very deliberately if you can go into what might still be finalized.

Louis Camilleri

Oh Bonnie I am not going to go into board deliberations, it is clear that prior to issuing an announcement of this nature, the board has given ample consideration to the risk reward balance, has considered all scenarios in considerable detail and they will be ready to go on January 31st. Is that clear? Hello. We got cut off.

Bonnie Herzon - Citigroup

Can you hear me? That was clear, but I was also curious Louis because you certainly stated a date which is helpful for the market with certainty, is there anything that could cause the board to actually announce something sooner or earlier? Is that possible? Are we to assume that is the absolute earliest?

Louis Camilleri

The board's announcement is very clear that the date is January 31st, Bonnie.

Bonnie Herzon - Citigroup

In terms of, moving over to business, PM USA a lot of the trade contacts that I have have indicated that they are somewhat open to this issue in terms of the order stock problems that they have been facing. Have you found that this has provided you company with an opportunity in anyway? Have you noticed anything or anything you can share with us on this topic?

Louis Camilleri

Our understanding Bonnie if there were stock shortages they were essentially at the wholesale level, not at the retail and therefore we haven't seen any movement towards us.

Bonnie Herzon - Citigroup

Won’t it eventually reach retail, if it is affecting wholesale?

Louis Camilleri

Not necessarily to the extent that they have ramped up production which I believe is the case.

Bonnie Herzon - Citigroup

I'd heard retail obviously some other retailers and I thought that might provide you with an opportunity in the future.

Louis Camilleri

I understand that it is predominantly wholesale.

Bonnie Herzon - Citigroup

And my final question is on Indonesia, Sampoerna is doing very well and I'm curious if you can elaborate on what was implemented or what you may have implemented to help you generate the volume increase of 9%.

Louis Camilleri

Well I think it is a whole gamut of things Bonnie. We started with a very strong company that we acquired and I think we've added to it, the management and when I say management both the ex-Sampoerna people and the PMI people together are doing a fabulous job.

Bonnie Herzon - Citigroup

When you say added to it I'm never going to get you to quantify by how much you invested in them.

Louis Camilleri

No, but as Dinny said we did very well on both the volume and the income line.

Bonnie Herzon - Citigroup

Well, It’s a great acquisition; I was just trying to have you share with us what you can bring to other businesses and maybe the possibilities for the future.

Louis Camilleri

Well, I suppose your question relates to future acquisitions. And you know we never comment on those Bonnie other than to say that PMI has grown through acquisitions in the past and continues to be interested and we have a number of promising prospects in the pipeline.

Bonnie Herzon - Citigroup

No, but bottom-line there are competitive advantages you bring to these businesses that allow you to increase the volume greater that what it was before, correct?

Louis Camilleri

That’s what we believe.

Bonnie Herzon - Citigroup

Alright, Thank you.

Operator

Your next question is coming from David Adelman from Morgan Stanley.

David Adelman – Morgan Stanley

Can you hear me? Hi Louis, I wanted to ask you a few things, first of all, why in conjunction with the Schwab certification ruling did the company then indicate that decision inevitably delayed the process because clearly it doesn't appear to be.

Louis Camilleri

David, lets be fair to when that statement was made and that statement was accurate when it was made. It was made within two hours or three hours of the ruling that was some 560 pages that came out and stayed almost very accurate at that time. Today the board has brought clarifications as to its timing and whether Schwab was delayed or not is somewhat irrelevant today, because I think the announcement is crystal clear.

David Adelman – Morgan Stanley

Ok, and Louis if you are so confident, and you know the decision you'll make on January 31st, why not just have the board, why didn't the board today declared the dividend of Kraft's payable at some future date?

Louis Camilleri

Well, I think I tried to address that in terms of what why January 31st, because of the orderly process, and the deliberate formal process that has to be carried out, David.

David Adelman – Morgan Stanley

Ok, and to be clear Louis if the industry's 23F motion in Schwab is not granted, that wouldn't delay or alter the board's assessment of the overall legal environment such that you wouldn't then proceed.

Louis Camilleri

I just have to repeat what I said earlier that the board is comfortable with the litigation environment, this is not without risk, but we are prepared for that and the obvious risk is the risk of an injunction. But we believe that such an action would not have merit and that we would ultimately prevail. Very important then, I think you know this David, but it is very important to realize that an injunction would have to be based on a finding that Altria is insolvent or that the decision is being done with fraudulent intent. And I think to find something on our account, would be extremely difficult.

David Adelman – Morgan Stanley

Louis, do you think the length of this of your restructuring effort granted in a lot of the ways and dynamics are outside of your control of dynamics and other quotes? But do you think that that has adversely affected some of the divisional operating performance?

Louis Camilleri

No I don't think so David. Clearly, would Kraft be better off independently, the answer is a crystal clear Yes. For all the reasons that we have enunciated in the past that's why this makes so much sense. The business purpose is so compelling that we have a very very strong case.

David Adelman – Morgan Stanley

And then lastly Louis on the issue of fraudulent conveyance in a potential injunction, can you find for us how long do you think that process, assuming that it pursued by the plaintiff how long that process might until you have resolution.

Louis Camilleri

David, I hope you do understand I am not about to divulge all the litigation strategy anyway. So I am not going to answer that question.

David Adelman – Morgan Stanley

Ok. Can I ask u one last thing? What can be done do you think broadly to accelerate PMI's rate of operating process growth and volume growth?

Louis Camilleri

You know, PMI has in recent years as you all know, really suffered from its strength, and its strength has been a significant position in the premium segment in the EU Markets, which have a lot of them gone through quite difficult times with France, Germany, Italy and now Spain, Portugal also.

And we've had significant tax increases that have hurt consumption and a number of public smoking restrictions that hurt consumption and clearly there has been significant growth in the low price segment, in part due to tax. Lot of these things have been addressed and most of them are behind us Italy and France, of course the trials where things are fixed now.

Spain we still have challenges as Dinny said. However you know our 3Q share was higher than the 2Q and in fact our performance probably was a bit better than the numbers which suggest because September shares was somewhat distorted by increase in the low price segment because they took a price increase.

We are still cautiously optimistic that the minimum exercise tax increase will be announced hopefully early in the New Year which clearly would help, as it has helped in France and Italy. Germany as Dinny said, cigarette consumption is actually looking much better than it has in the past. That’s because tobacco portions are essentially eliminated.

The concern we have is really twofold. Initial indications are that smokers are moving to fine cuts to non-domestic cigarettes and then to domestic cigarettes. So that's one concern with hope that will involve movement back to conventional cigarettes. And clearly the other issue is the advent of a VIT increase from 16% to 19 % in January and as you know we took the price increase .We announced the price increase. Now most of the concerns about what's in Europe are behind us.

Japan, we probably had to focus so much on the Marlboro take back and you know what a reward of that was, that we probably lagged competition in terms of new products and I think we have a pretty exiting pipe line going forward. So that was a conscious decision to really focus on the Marlboro take back and ensure that went as smoothly as possible and that has been the case. Now we are working on the rest of the brands portfolio. And elsewhere we are actually doing pretty well. David, this Quarter I had number of negatives but I still feel pretty confident about the PMI going forward.

David Adelman – Morgan Stanley

Ok. Great Louis. Thank you very much.

Operator

Thank you. Your next question is coming from Judy Hong from Goldman Sachs.

Judy Hong – Goldman Sachs

Hi Louis, Hi Dinny. Louis, I wonder If you could talk a lit bit of about the board's view on the PMI spin-off and clearly today's announcement makes it pretty clear about the Kraft's spin-off. But what is the board's view on the potential PMI spin-off and the potential timing of that piece?

Louis Camilleri

Judy, I don't want to elaborate at this stage. We already said let's go one step at a time. Clearly that is something of significant consideration to the board. But let’s do step one close.

Judy Hong – Goldman Sachs

Given some of the legal development that has happened in the past, those developments playing towards thinking that next piece could come either sooner or later or is that irrelevant?

Louis Camilleri

That’s irrelevant. We are very comfortable with the litigation environment, how it has progressed and in the future.

Judy Hong – Goldman Sachs

Ok. Then in terms of the Moody's upgrade yesterday does that indicate any heightened intention to resume share buyback in front of the restructuring or are we going to basically wait until any restructuring takes place on the share buyback?

Louis Camilleri

I think Judy that’s clearly that the big reward is the restructuring. We would like these companies to start life with very strong balance sheets and if thereafter they will determine their own optimal structures and dividend and share buyback policy.

Judy Hong – Goldman Sachs

Ok and then just in terms of the operations can you say, can you talk a lit bit about the level of profits in the 3Q. It looks like even if you take some of the spending related to the excise tax ballot initiative out, the level of the rate of profit growth slowed in the 3Q. Can you just talk about what happened there?

Louis Camilleri

I can try Judy. I should mention one thing because we told about Moody just earlier. I've I just been passed a relief here where S&P has also revised its rating outlook from stable to positive for the company. So we see that as a very positive move as well. In terms of PM USA part of the issue was if I recall correctly other than spending for the ballot initiatives leave cost in terms of the lifer implications and the benefit we have got last year from the quarter buyouts from the 2005 purchases, which had a relatively significant impact. And I would say that in terms of promotional levels, that pretty well constant vs. the prior year Judy so if that’s what u r driving at that not one of the drivers.

Judy Hong – Goldman Sachs

Ok. Thank you.

Operator

(Operator Instructions) Your next question is coming from Christopher Growe from A. G. Edwards.

Christopher Growe – A. G. Edwards

Good afternoon Louis and Dinny. Related to other elements of the corporate restructuring like share re-purchase or any of the other things you could do with the cash, have you know, what the board may decide on January 31st. Or even considerations prior to the full Kraft spin-off have been announced?

Louis Camilleri

I think I addressed this in a prior question, we do this one step at a time Chris, what’s on the table now is the Kraft Spin-off.

Christopher Growe – A. G. Edwards

My second questions is relative to PMI. With pretty meaningful or beneficial foreign exchange coming through in that division right now do you believe that PMI needs incremental, like reinvestment back into the brand or in business in certain countries and maybe take some of that, for example some foreign exchange upside, to reinvest back into the business?

Louis Camilleri

Well, let me first question the premise of your question which is “Significant currency benefits”. In the quarter it was $5 million, so we are not seeing huge currency benefits here. The Yen has been particularly weak and the Turkish Lira certainly in the third quarter was a significant factor as well, which more than offset what you would believe is a weaker dollar. So, without saying, a weak dollar giving us currency favorability that we could re-invest, Chris, So I just question the premise.

Christopher Growe – A. G. Edwards

Wasn’t foreign exchange, used as a reason to bring up the bottom end of the guidance range? I know that is a projection going forward that is based on a current currency rates. It seems more favorable for the fourth quarter, so I was kind of looking ahead here, and even in early 07, that was the premise of the question.

Louis Camilleri

It would be fair to say that currency has improved, versus our initial outlook. And that is why we narrowed the range to the higher end of the original range. That would suggest that we are not re-investing it.

Christopher Growe – A. G. Edwards

Do you believe PMI needs to re-invest more heavily?

Louis Camilleri

I think PMI’s investments are at the appropriate levels.

Christopher Growe – A. G. Edwards

I appreciate that. Thank You.

Operator

Your next question is from Philip Ferguson from Credit Suisse.

Philip Ferguson - Credit Suisse

First my congratulations on the Moody’s upgrade. Long overdue here. Dinny just a housekeeping question here first. Can you tell us at the end of the quarter, what the net worth position was of the tobacco stuff please?

Dinyar Devitre

It was $12.8 billion Philip.

Philip Ferguson - Credit Suisse

My next few questions are for Louis. Louis, some of the dynamics from the US market as also going perhaps to Western Europe and referring specifically to more smoking ban being implemented, the tax rates going up, and given our outlook over the next number of years for international consumption to actually decline on a global basis, we would argue that we may need to see a global consolidation and we would expect PMI obviously to play a leading role in that.

Can you perhaps share two things with us; first, can you refresh our minds in terms of what your parameters are when you typically do look at acquisition opportunities? and then second, given that we don’t have a further word yet on a potential spin-off of PMI, is the timing of any activity with regard to PMI going to play any role in any potential acquisition?

Louis Camilleri

There are several questions here. I think we have been pretty clear that PMI is very focused on acquisitions as one of the elements of its growth strategy going forward. I do not believe that a potential restructuring of the company would in any way affect acquisitions by PMI. They would continue, and Indonesia was a perfect example of that.

And as I said earlier, that we do have a pipeline of potential projects. Whether they would material or not is another questions though, though we are following these through. With regard to, whether there will be a cycle of industry consolidation or not, that remains an open question. Given our size, clearly we have a number of anti trust issues Philip, that have to be given consideration to.

With regards to the precise parameters of our acquisitions, we want to ensure that we have attractive economic returns from those acquisitions, and clearly we would want EPS accretions from those acquisitions but that would not be enough. Most acquisitions are accretive to EPS when you don’t have to amortize good will and therefore it is really a focus on attractive economic returns.

Philip Ferguson - Credit Suisse

My second question Louis, the fact that Imperial Tobacco recently applied to MSA is further validation and basically also concurs the view of your board that there is a material and hopefully sustainable improvement in the legal environment. Depending on how they decide ultimately on how to enter the US market, whether it is through organic means or whether it is through acquisitions, how do you think that might impact the competitive environment in the US and what game plan do you have, in place in case they were to go the acquisition route?

Louis Camilleri

Well, Clearly we have the deepest respect for Imperial. If they go through the acquisition route, the ownership would change at one of the competitors. I don’t think it will make a material difference to PM USA strategy or competitive position. If they grow organically it would be quite a slog, but clearly we have the highest regard for imperial and would be an additional competitor potentially.

Philip Ferguson - Credit Suisse

Ok. My next question is with regard to the smokeless segment. Can you provide us an update in terms of how the current test is going and when you might plan to expand that test, and secondly again from a competitive perspective the fact that this morning Swedish announced that they are teaming up with Lorillard to develop smokeless product. Do you see that as a validation of the growth potential of the smokeless sector and could that have any impact on how you think how you will place that sector in? Whether you plan to accelerate your current plans? Thank you.

Louis Camilleri

Clearly it is a growth segment. So I am not at all surprised that all industry players are interested in that segment. And there are components of that segment. And so that is not a surprise to me. It is a growth segment and I think it is a segment that is here to stay and we will continue to grow. With regard to our test market of tobacco, I think we are learning a lot, and we continue to learn from that test market. As to future initiatives, I would not want to give you any timing other than to say there will be future initiatives and we've said for sometime that we are committed to participating in the smokeless category in a rather large way. We believe we have the infrastructure in place and we are learning through this test market and have plans to do other things going forward.

Philip Ferguson - Credit Suisse

And the intention Louis, I am trying to go out on a limb here, I do apologize but the intention would be to accomplish that organically. Correct?

Louis Camilleri

Of course, you know that is why I mentioned the infrastructure the preference would be to do it organically, but I would not, in any way say that we would not pursue any acquisitions that didn’t make perfect sense and better criteria and has the potential to make attractive economic returns.

Philip Ferguson - Credit Suisse

Thank you very much gentlemen.

Operator

Thank you. Your next question is coming from Erik Bloomquist from JP Morgan.

Erik Bloomquist – JP Morgan

Hi Good afternoon. Three questions, first on PM USA. You noted that post breakup each of the companies would control their own capital structure. I was wondering if you could comment at all on what we might expect from PM USA in terms of acquisitions outside of the US borders.

Louis Camilleri

That is a premature question Eric, so I am not prepared to elaborate on that. I hope you understand.

Erik Bloomquist – JP Morgan

Yes, Thank You. Secondly in terms of operations in PMI. Russia looks to be performing very well, with the up-trading. I was wondering if you could provide us more color on that and in particular two components, one, the sustainability of that up-trading and two, why L&M was down if it was a victim of the success in the up-trading up to Marlboro or is there something else going on in that market?

Louis Camilleri

You are right. Russia there has been considerable up-trading to the premium section. This is a phenomenon that has been going on for some time. L&M is partially suffering from that, I think L&M’s brand equity has been somewhat weakened in the recent past and it is something we are addressing vigorously, and there are actions in place over the next year to reinforce that brand, it is a very important brand.

But we are pleased with our premium brand offerings. We have some exciting new products in the pipeline, in the premium offerings. I would say that L&M’s weakness is probably linked to the fact that it is somewhat perceive as a full flavor brand, and the market is moving towards more light cigarettes. Both low-tar and nicotine cigarettes and that is something we need to address quite vigorously. With L&M and we will do that.

Am I pleased with our share performance? no, I think we could be doing better and I am sure we will be doing better.

Erik Bloomquist – JP Morgan

Pulling on in Russia. We are expecting excise tax increases in 07-08 and potentially in 09 as well. Is that something that will impact the up trading, or is that something that will simply be absorbed as economic growth continues and consumers continue to look for premium products like Philip Morris’s portfolio.

Louis Camilleri

I would say they would continue the move towards premium because you are right. there are going to be tax increases but what is very important to know is that whilst a couple of years ago there was a change from specific to ad-valorem, it is now come back predominantly to specific tax structure. And therefore that is always a positive for the development of the premium segments.

Erik Bloomquist – JP Morgan

Last question is concerning Japan, the volume declines, what we were thinking of in terms of trade de-load, but on a year-to-date basis or on an overall point of view, could you give us some color as to what we might expect for the overall market as volume declines.

Louis Camilleri

We are expecting for the full year Eric, consumption decline of about 3.5% to 4%.

Erik Bloomquist – JP Morgan

Ok, and then with volume declines of really that little, can you give us any kind of indications as to the magnitude of the benefit of the price increase that you have take across. I think it is about 35% of the PMI volumes in Japan.

Louis Camilleri

I am not going to give you that number.

Operator

Thank you. Your next question is coming from Ann Gurkin from Davenport.

Ann Gurkin – Davenport

Good afternoon. If we could start with PMI, The acquisition of a privately owned Swedish company. Can you talk about the rationale behind that acquisition?

Louis Camilleri

We purchased a very small, I would call it minute company in Sweden and this wasn’t dollars of any magnitude that’s in the radar screen, I can assure you. It was really part of our strategy to learn more and more about the smokeless category and to participate in that category. It was part of our strategy and we are getting know-how. They have a few important patents in terms of snus that we believe, can be further developed.

Ann Gurkin – Davenport

Great. And switching back to the US, in terms of proposed state excise taxes, particularly in California, can you walk me through to help me understand how you pre preparing if the worst case scenario should occur in that the proposition should get voted in?

Louis Camilleri

Yeah, well, clearly that is a big question mark for next year as to the impact of California. And that is why the industry is trying to vigorously oppose such a huge tax increase, as a wrong solution. We are concerned that it will have adverse ramifications on consumption, Even on California state coffers because an increase of that magnitude may have unintended consequences in terms of cross border flows of cigarettes etc. So I would say it would be very difficult to determine what the impact will be. Clearly it would be negative, but our hope is that the proposition would not be voted. That is why we are opposing it so vigorously.

Ann Gurkin – Davenport

How are your inventory levels in California?

Louis Camilleri

I am not going to disclose what are inventory levels are in California.

Ann Gurkin – Davenport

Are you comfortable with where they are right now or are they too high.

Louis Camilleri

We are comfortable with our inventory levels everywhere.

Ann Gurkin – Davenport

And lastly, when we get rich, we see that the research center go up, am just curious when we might hear some news from PM USA regarding products that they are working outside of direct JC category tobacco, outside of tobacco. When should we hear news?

Louis Camilleri

You will hear news when they are ready.

Ann Gurkin – Davenport

How about in the next one/two year? Is that a fair assessment?

Louis Camilleri

They are very focused on a number of initiatives and they would be announced in good time.

Ann Gurkin – Davenport

Thank You.

Operator

Thank You. Your next question is coming from Annette Florence from Business Week magazine.

Annette Florence - Business Week magazine

Building on the second last question, I wonder if you could assess globally how big challenge excise tax increases are for the company. If you could give me a sense of how concerned are you about them now versus historical. Whether you are more or less concerned, and what is the trend like?

Louis Camilleri

I don’t think I am more concerned than I was in the past. Excise taxes are a fact of life in Tobacco. The tax structure is very important. So I am more interested in tax structure than tax incidence. And historically we have had quite a lot of success in ensuring that the tax structure are fair, and there has been quite a lot of movement in that regard worldwide. Even here in the smokeless category there are initiatives to ensure that the taxes are of the specific nature rather than that of an ad-valorem nature.

Now the big issue with significant tax increase is that they also have unintended consequences, and that has been the history of the tobacco industry, and that is why we oppose dramatic and draconian tax increases, because they always have detrimental effects, we are not opposed to fair tax increase, but when they become draconian they have the potential of disrupting the industry.

Annette Florence - Business Week magazine

You mentioned that you are cautiously optimistic that there may be a change in Spain early next year. Could you just elaborate on why are you cautiously optimistic about that? What difference would that make to you?

Louis Camilleri

Well the good news what that earlier this year Spain institute a minimum excise tax. In so doing the government had essentially publicly disclosed that they would like to see a minimum price of €2 a pack. The Minimum excise tax that was imposed, they believed at the time would do the trick; it did not do the trick. There are products still selling at €1.75, €1.85 and some have increased to €1.95, but they have not reached the €2 a pack threshold that the government had set as a health policy. Because of that our sense is that the government will intervene and increase the minimum excise Tax. Is that clear?

Annette Florence - Business Week magazine

Thank You. Yeah.

Operator

Thank You. Your next question is coming from Andrew Martin from NY Times.

Andrew Martin - NY Times

Hello. Just saw quickly, your release says that this announcement in January. The way it is written it says the board could announce/finalize its decision on Kraft after the Schwab case is completed. Could you give me any idea what the intention is in terms of timing. Should we be looking at next spring or months, weeks after? Do you have any sense of that?

Louis Camilleri

I am not going to preempt what the board will decide as the precise dividend record date. They will decide that and announce that on January 31st.

Operator

Thank You. Your next question is coming from Thomas, Gartner Group.

Thomas - Gartner Group

Louise, a couple of questions on international, I am curious, on updates on developments in china, if you could bring up to date on those. A less pleasant topic might be for Bill or somebody else to comment about Manitoba provincial health claims that I gather may have a chance of going forward.

Louis Camilleri

China first, China you know, we had hoped we would be producing, tom, regretfully, we are not yet. Things have been rather slow. Nothing material, there has been a whole slew of formalities that have had to be completed, we are essentially done now. I won’t give you the whole list of license and other permissions that had to be granted from various departments, but we are essentially there. There has been progress on the joint venture as well, and thy will be launching brands early next year as well, and we are hoping that in 07 we will be in full work both in china and for the international joint venture. Regretfully, bill is not here, Tom, so can’t comment on the Manitoba issue. I am aware of it and it follows what ever lese has been going on in Canada and you know, our sense is it is going to take a very very long time. You know our presence in Canada is limited to a minority stake in Rothmans, Benson and Hedges. So, there isn’t really a material exposure that we have.

Thomas - Gartner Group

Great and last, just the dispositions of either the Philip Morris capital group, or SAB Miller, as you consider the potential for a spin-off. I suspect, it’s too early to comment but how would you see those two as non operating assets handled through the reorganization.

Louis Camilleri

It is clearly premature PMCC we have chosen the strategy which I think is the best strategy to exit at that time, and frankly a sale we do not believe would give us appropriate value at that time. Because it would trigger the acceleration of all sorts of Tax claims and we potentially would not get the benefit of the increases over the residual value that we believe are a part of that portfolio. With regard to SAB miller we are very pleased with that investment, and we see no reason at this stage to exit partially or fully from that investment, we are quite happy to ride along with SAB Millers success.

Thomas - Gartner Group

Thank you and good luck in Brooklyn.

Louis Camilleri

Thank you very much.

Operator

Thank you. This concludes the Q&A Section. I would like to turn back phone over to Mr. Rolli for any closing remarks.

Nicholas Rolli

I just wanted to thank everyone for joining us in today’s call. We will look forward to speaking with you again next quarter. Thank you all for joining us.

Operator

Thank you. Thank you callers. This concludes today’s teleconference. You may disconnect your line and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Altria Group Q3 2006 Earnings Call Transcript
This Transcript
All Transcripts