Altria Group (MO) is the leading tobacco company in the U.S. The company has a dominant market position in the U.S., with a market share of more than 50%. The company has been making aggressive efforts to expand its smokeless product portfolio to tap available growth opportunities. Recent weakness in the stock price presents a good investment option for dividend-seeking investors to initiate a buy position; MO currently offers a high dividend yield of 5.15%.
The company reported mixed financial results for 4Q2013, mainly due to lower-than-expected sales growth. MO reported net sales of $4.4 billion for 4Q2013, down 1.3% year-on-year, missing consensus estimates of approximately $4.5 billion. The company's top line results were adversely affected by a 5.8% volume decline. The company registered an EPS of $0.57 for the recent fourth quarter, up 3.5%, missing consensus estimates of $0.58.
Despite a 5.8% volume decline, gross profit and operating income for the company increased by 1% and 1.9%, respectively, in 4Q2013, mainly driven by a 4.1% increase in pricing for the smokeable segment. Sales volume for the company declined across all its major brands, including a 5.7% drop for its Marlboro brand and an unexpected 2.1% drop in its discount brands. The drop in sales volume for discount brands was unexpected, as it experienced double digit growth in 2012. An approximate 1.7% drop in the sales volume in 4Q2013 came as a result of inventory movement timing, which is expected to positively affect sales volume in 1H2014. Despite the large drop in sales volume for the company in the fourth quarter, the company's total cigarette retail share increased by 30bps year-on-year, to 50.7% in 4Q2013, mainly driven by a 20bps increase in Marlboro retail's share. In the recent past, sales volumes for traditional cigarettes have been on a decline, as a result of growth in alternate tobacco products, higher taxes and tougher regulations.
Stock Price Catalysts
As the sales volume of traditional cigarettes is on the decline, tobacco companies are aggressively working to expand their portfolios of other tobacco products, including e-cigarettes. Last year MO launched its e-cigarettes, MarkTen. The company continues to test the market for its MarkTen in Arizona and Indiana. The company is in the early stages of a MarkTen launch and has been bringing changes to the product according to market preferences; recently it updated the product's flavor process, packaging and promotional plan. To further ramp up its efforts to expand into the e-cigarette market, the company last week announced to acquire the E-vapor business segment of Green Smoke, Inc. for $110 million in cash and incentive payments of up to $20 million. The acquisition will help MO quickly get in the market and expand its presence, as the company has an efficient marketing platform. However, on the downside, the acquisition will put pressure on the FDA to regulate the e-cigarette market due to its growing existence.
Due to declining sales volume for the industry, tobacco companies are relying on cost saving initiatives and share repurchases to fuel bottom line results. The company recently, at the end of 2013, completed a $400 million cost saving program, and I was expecting the company to announce the next round of productivity savings for the future, which it did not, to protect its margins. However, I still believe the company will come up with another cost saving program for the future, in 1H2014, which will provide more visibility to future earnings and increase investor confidence. Share repurchases is another tool used by the company to grow its bottom line results. The company has been undertaking its $1 billion share repurchase program, under which $457 million is remaining, which is set to last through 3Q2014. Since 2011, the company has repurchased approximately $3 billion worth of common stocks, representing 4.3% of the current market capitalization. I also expect MO to announce in early 2H2014 to extend and increase its share repurchase program for the future.
MO is aiming for an EPS growth of 6%-9% for 2014, as compared to the long term EPS growth target of 7%-9%. The company's earnings are likely to benefit in 2014 from a lower tax rate and lower interest expense. Due to partial repayment of outstanding debt in late 2013, the company's average interest cost dropped to approximately 6% in 2013, as compared to 7% in 2012. The company is expected to go for another debt refinancing in 1H2014, which is likely to further lower interest cost and positively impact EPS.
I believe that despite the recent weakness in the sales and sales volume, MO remains a good investment option for dividend-seeking investors, as it currently offers a high dividend yield of 5.15%. The stock is down 10% year-to-date, which presents a good entry point for long term investors. I believe that by early 2H2014, the company will announce a productivity program and share repurchase program for future years, which will portend well for the stock price. Also, MO's dominant market share, strong cash flows, steady bottom line growth and stable earnings base (as it does not have exposure to unpredictable emerging markets and foreign exchange headwinds) support my bullish stance on the stock. Analysts are expecting a robust growth rate of 7.5% per annum for MO. Moreover, its high dividend yield, along with an 80% payout ratio, limits the downside to the stock price.
The imposition of higher taxes and FDA regulations pose a risk to my bullish stance on MO. Also, the company operates in an industry that has been facing continuous decline in sales volume, which is being partially offset by the company through price increases, cost control measures and share repurchases. The company's failure to continue increasing prices, due to weak consumer spending, and come up with an additional cost saving program targeting the coming years are additional risks to my bullish thesis on MO. Furthermore, the volatility and upward trend in bond yields is likely to put pressure on the stock price multiples, as MO is a dividend paying stock. The following table shows the declining cigarette volumes for the four leading tobacco companies.
Philip Morris (PM)
Reynolds American (RAI)
Source: Companies Reports