Altria Group, Inc. (NYSE:MO)
Barclays Capital Back to School Conference Call
September 03, 2014, 12:45 PM ET
Howard Willard – EVP, Chief Financial Officer
I think we will get started with our next presentation. It's my pleasure to welcome our next speaker, Howard Willard, the Chief Financial Officer of Altria Group. Howard has been with the company since 1992 and has held numerous leadership positions including Executive Vice President of Strategy and Business Development. We look forward to hearing Howard's insights on Altria in the broader U.S. tobacco market, including the outlook for cigarette volume and pricing trends, the regulatory landscape and of course the development of alternative tobacco products such as electronic cigarettes.
With that, I will turn it over to Howard.
Thank you and good afternoon. Before we begin, please review the Safe Harbor statement in today's presentation and the forward-looking and cautionary statement section in today's press release for a description of the various factors that could cause our actual results to differ materially from projections included in today's remarks. Reconciliations and further explanations of non-GAAP financial measures discussed today are available on Altria.com.
Billy Gifford, Altria's head of strategy and business development, and Murray Garnick, who manages litigation on behalf of our companies join me today. Following the presentation, we will all be available to answer your questions.
Today we will focus on the progress we are making against our financial goals and business strategies. For several years we have been pursuing two long-term financial goals which are, to grow adjusted diluted earnings per share at an average annual rate of 7% to 9% and maintain a target dividend payout ratio of approximately 80% of adjusted diluted EPS. We are proud of our strong track record in achieving those goals. From 2008 through 2013, Altria grew adjusted diluted EPS at a compounded annual rate of 7.6%, despite difficult economic conditions and historic federal excise tax increase and significant regulatory change. We have also consistently grown our dividend. Altria's dividend grew at a compounded annual rate of 8.4% over the same period, and we have maintained a dividend payout ratio of approximately 80%, currently the highest in the S&P food, beverage and tobacco index.
In the first half of 2014, Altria's adjusted diluted EPS grew 5.2% and we expect to deliver full-year adjusted diluted EPS in a range of $2.54 to $2.59, representing a growth rate of 7% to 9%. In August we raised our dividend 8.3% to an annualized dividend rate of $2.08 per share. We continue to be well positioned to deliver against our financial goals in 2014.
We remain focused on three key strategies, maximizing income from our core premium tobacco businesses over the long-term, growing new income streams through innovative products and managing our diverse income streams and strong balance sheet to deliver consistent financial performance. Altria has delivered consistent strong returns for shareholders fueled by our core tobacco businesses. Our company's industry leading premium brands have delivered superior margins and strong cash flows.
Our first strategy is to maximize income from our core tobacco businesses over the long-term. Let's begin with the cigarette category which is characterized by two key dynamics. First, the leading brands have continued to grow within the premium cigarette segment for many years. Between 2008 and 2013, the three leading premium brands combined, grew their retail share of the premium segment in annual average of about 1.2 share points to more than 85%. That trend continued in the first half of 2014. Among these brands, Marlboro is the undisputed leader of the cigarette category at almost 44% bigger than the next 10 brands combined.
Second, cigarette volumes have been declining for decades. Volumes have been declining in a range of 3% to 4% for the past three years. Philip Morris USA estimates that the total industry cigarette volumes declined at a rate of approximately 4.5% during the first half of 2014. We will continue to monitor volumes carefully. So far this year, we are very pleased with Marlboro's performance and the results from our smokeable products segment. Our strategy for the smokeable segment is to maximize income while maintaining modest share momentum over time on Marlboro in cigarettes and on Black & Mild in machine made large cigars.
Consistent with this strategy, between 2008 and 2013 smokable products adjusted operating companies income grew at a compounded annual rate of 4.2%. For the first half of 2014, adjusted operating companies income was up 4.9%. Additionally over the past five years, Marlboro has delivered against its share strategy by achieving an average of nearly two-tenths of a retail share growth annually. In the first half of 2014, Marlboro continued its momentum with one-tenth of a retail share growth to 43.8%. Pricing is a key income driver for the smokeable segment. Since 2008, our smokeable segment grew revenues net of excise taxes per thousand units at a compounded annual rate of 5.2%. For the first half of 2014, revenues net of excise taxes per thousand units increased 4.9%.
In addition, we have carefully managed costs in these businesses over time. We have held our controllable cost per thousand units in the smokeable products segment nearly flat from 2008 through 2013. For the first half of 2014, controllable cost per thousand units increased 2% versus the prior year period. Consequently, the smokeable segment expanded adjusted operating companies income margins on average 1.7 percentage points annually over the past five years and 1.6 percentage points in the first half to 44.1%. Marlboro's strong equity and loyalty have supported its share momentum and profitability over time.
PM USA has made careful investments in Marlboro for many decades. A few years ago, PM USA established a new brand architecture featuring four flavor families that set the course for further product, packaging and marketing innovations that are helping to secure Marlboro's equity and relevance into the future. Each of Marlboro's flavor families, red, gold, green and black expresses the brand values in a unique way, allowing the brand to broaden its offerings and more effectively engage both loyal and competitive adult smokers.
Investments behind Marlboro have continued to strengthen the brand. Annually, we conduct studies to monitor key brand measures including equity, status and momentum. Over the past four years, Marlboro has maintained or grown its equity and achieved top equity scores among major domestic cigarette brands. Further, Marlboro consistently achieved equity scores that are higher among adult smokers 21 to 29 than its overall score over the same period.
Marlboro's newest flavor family, the Marlboro Black family, has helped the brand deliver consistent retail share growth supported by innovative product offerings like Marlboro NXT with capsule technology in 2012 and Marlboro Edge with bold smooth flavor in 2013. The Marlboro Black family has achieved 14 consecutive quarters of growth since January 2011 and built a strong position among adult smokers 21 to 29.
PM USA connects adult smokers 21 and older to Marlboro's flavor families through direct mail, email and Marlboro.com. Over the past few years, PM USA has enhanced Marlboro.com which is among the largest CPG websites in the U.S. based on average number of unique visitors. In the past 12 months, the number of unique visitors to the site has grown 15% and mobile logins are up 78%.
Let's take a closer look at how Marlboro.com connects adult smokers 21 and older to Marlboro's flavor families.
Further next month, PM USA plans to begin testing its latest consumer engagement innovation, mobile value delivery, which combines strong retail relationships, the outstanding Marlboro.com platform and the power of the adult smoker database. Age verified adult smokers will be able to instantly redeem coupons by using your mobile phone at participating retailers. It's another example of how PM USA invests in Marlboro to continue delivering on the past 60 years of retail share growth.
In smokeless products, the category dynamics are, of course, different. We look at smokeless industry volume using a 12-month view. Industry volumes have grown annually at or above 5% since 2009. As of the end of June 2014, we estimate volume grew about 4.5% over the past 12 months. This slower rate reflects second quarter growth of approximately 2%. We still believe that smokeless industry trends are best judged over the longer horizon and we will continue to monitor smokeless volume developments closely.
U.S. Smokeless Tobacco Company's strategy is to grow income by growing volume at or ahead of the category and to maintain modest share momentum on Copenhagen and Skoal combined. Since Altria acquired UST in 2009, we have made great progress against this strategy. Smokeless products adjusted operating companies income grew at a compounded annual rate of 12.9% through 2013. In the first half of 2014, smokeless products operating companies income was up 6.5%.
USSTC also grew combined Copenhagen and Skoal retail share an average of nine-tenths of a share point per year. For the first half of 2014, Copenhagen and Skoal achieved their highest combined share since the acquisition at 51 share points. USSTC maintains its leadership position in smokeless on the strength of its two premium brands. Our third-party study continues to validate the terrific equities of both Copenhagen and Skoal, which adult dippers have consistently ranked at the top among moist smokeless tobacco brands.
Despite the strong combined performance of Copenhagen and Skoal, share trends on Skoal called for a refresh of its value equation. USSTC began 2014 by enhancing Skoal's position, starting with its equity campaign. USSTC brought back its successful, Skoal A Pinch Better, campaign, which highlights the simple enjoyment of being a guy, Skoal's sweet spot in the smokeless category. USSTC also focused on narrowing price gaps on Skoal Classic that had widened in some states beyond 55%.
As of the end of the second quarter, USSTC reduced the price gap between Skoal Classic and the leading discount brand to a national average of approximately 45%. USSTC expanded its Skoal efforts through the second and third quarters. Of course, these efforts take time and the program has only been in market for a few months. We will continue to watch its progress closely.
USSTC's investments in Skoal are designed to help drive the long-term combined performance of Copenhagen and Skoal. Thanks to its strong equity and support from product expansions in the past few years, Copenhagen grew its retail share at an annual average of 1.7 percentage points from 2009 through 2013. In the first half of 2014, Copenhagen continued its strong performance with 1.5 points of share growth. Overall, the smokeless products segment has continued to sustain high margins and last year generated more than $1 billion in adjusted operating companies income.
Turning to wine. Ste. Michelle Wine Estates is one of the fastest growing premium wine companies in the U.S. From 2009 through 2013, Ste. Michelle grew adjusted operating companies income at a compounded annual rate of 12.8%. In the first half of 2014, Ste. Michelle grew operating companies income more than 11%. Recent growth has been driven by Chateau Ste. Michelle and the success of 14 Hands, which is now the fastest growing top 10 premium wine brand in the country. Ste. Michelle continues to achieve broad acclaim for its terrific portfolio of wines and to deliver strong financial results for Altria.
Our second strategy reflects the balance between focusing on our strong successful core businesses and innovating for the future. This is a very dynamic time for the U.S. tobacco industry and Altria's operating companies are investing to maintain their leadership position. So today I will share how Altria assesses some of these dynamics, primarily related to the e-vapor category.
Our companies have built deep expertise over many years in understanding adult tobacco consumers and reading the marketplace. Over the past couple of years, we have refreshed that capability in light of changing adult tobacco consumer preferences, new channels and evolving products. Here are a few things we have learned.
First, the e-vapor category continues to grow rapidly, particularly in certain trade channels, though the pace of category growth may be slowing. Last year at Barclays, we projected 2013 e-vapor consumer expenditures at approximately $1 billion. Today with a better measurement system, we estimate that 2013 e-vapor dollar sales were about $1.3 billion and based on annualizing first-half 2014 sales information, we estimate 2014 consumer expenditures of approximately $1.8 billion. This represents estimated e-vapor dollar sales growth of 160% between 2012 and 2013 and approximately 40% projected growth between 2013 and 2014.
Second, while nearly all adult smokers are aware of e-vapor products and approximately 60% have tried them, we are still not seeing widespread conversion of adult smokers to e-vapor products. So although adult consumer interest in e-vapor remains high, e-vapor dollar sales represent a small fraction of expenditures across total tobacco categories. We believe that a slowing pace of growth and still low conversion rates show that today's products are not fully meeting adult consumer expectations.
In Nu Mark's research, we find that adult smokers and vapers are evaluating products based on many different size, flavor and performance factors. Many adult smokers and vapers are looking for a familiar experience, while others are seeking something different. Nu Mark is developing a great product portfolio to address these insights.
This time last year, we announced a test market of MarkTen e-vapor products, for adult smokers or vapers seeking a familiar taste, form and experience. Following two test markets, the MarkTen national expansion began in June. MarkTen has achieved distribution in over 60,000 stores, primarily in the western half of the U.S. In August, MarkTen ranked in the top three e-vapor brands in the western U.S. Nu Mark expects to begin broad-based eastern U.S. distribution in October.
Throughout the past year, Nu Mark has applied learnings from adult consumer feedback and made at least a dozen product and process changes to enhance the MarkTen value equation. For example, this fall MarkTen will be available in two nicotine concentrations, 1.5% and 2.5% nicotine by weight.
Further, Nu Mark acquired the e-vapor business of Green Smoke in April. By adding Green Smoke's technology, supply chain capability and experienced talent to Nu Mark's resources, Nu Mark is building a product pipeline with offerings to complement its current MarkTen products. We will share more details on our plans when the time is right.
In addition, our companies also have access to Philip Morris International heat-not-burn tobacco products for the U.S. to provide other innovative offerings for adult smokers. PMI has announced it is preparing to commercially test its Platform 1 product later this year. In addition, we are collaborating with PMI to support an FDA application in the U.S. for a Modified-Risk Tobacco Product.
Over time, we expect that product innovation, taxation and regulation will influence growth in e-vapor and other novel, non-combustible products. In August, we submitted comprehensive comments regarding FDA's proposed deeming regulation. Our full submission is available at altria.com.
In short, we believe the combination of new, innovative and potentially less harmful tobacco products and adult tobacco consumer interest in them presents FDA with an unprecedented opportunity to reduce the harm associated with cigarette use. In our comments, we urged FDA to implement a regulatory framework for newly deemed tobacco products that is grounded in science and evidence, recognizes the differences between categories of tobacco products, respects the rights of adult tobacco consumers to make informed choices and fosters innovation in tobacco products that may have the potential to reduce harm.
We believe the agency can achieve these goals in a number of ways. For example, FDA should support manufacturers' efforts to bring potentially reduced-risk products to market by allowing them to rely on products on the market at the time FDA finalizes its deeming rule to support new product applications. FDA can also support innovation by establishing an accelerated authorization process for newly deemed products. In summary, as adult consumer preferences evolve, the marketplace responds and the regulatory landscape changes, we believe that our companies are well-prepared for what may lie ahead.
Our final strategy is managing our diverse income streams and strong balance sheet to achieve consistent results. Our leadership across tobacco categories and diverse business model differentiate Altria from our peers. In a dynamic environment, they provide earnings and a balance sheet that has delivered consistent, strong returns for shareholders.
For example, adjusted equity earnings from our 27% stake in SABMiller have grown from $552 million in 2008 to more than $1 billion in 2013, a compounded annual growth rate of 13.1%. The market value of Altria's interest has grown from $7.3 billion at year-end 2008 to $23.5 billion as of July 31, 2014. Our position in SABMiller allows us to participate in the global beer profit pool and provides a potential source of liquidity. We regularly evaluate our interest in SABMiller and currently believe maintaining the investment is in our shareholders' best interest.
Our diverse business model and strong balance sheet support our strong and growing dividend and our ability to enhance shareholder returns through share repurchases. Combined dividends paid and shares repurchased have delivered almost $24 billion to shareholders since 2008. Compared to other income-generating investments, Altria currently delivers an attractive dividend yield of 4.9%. We are proud to say we have increased our dividend 48 times in the last 45 years.
To further reward shareholders, in July Altria announced a new $1 billion share repurchase program that we expect to complete by the end of 2015. Both dividends and share repurchases are subject to the discretion of our board.
In conclusion, we remain committed to our long-term financial goals to deliver adjusted diluted EPS growth in a range of 7% to 9% and achieve a target dividend payout ratio of approximately 80% of adjusted diluted EPS. To do so, first we are maximizing our strong core businesses for the long term. Our operating companies' brands are leaders within their respective categories and we invest to keep them vibrant and relevant. Second, we are making disciplined investments in innovation for the future. And third, we manage our diverse business model and strong balance sheet with the objective of delivering stable earnings growth and consistent shareholder returns year after year.
In fact, over the past five years, Altria has produced excellent returns representing a total shareholder return of 245%, outpacing both the S&P 500 and the Food Beverage and Tobacco Index. As of August 22, Altria's year-to-date total shareholder return of 13.7% is outperforming both indices again.
Thus far, we are pleased with our 2014 business performance and believe our companies' full-year plans are on track. Thanks for your attention. Before I take your questions, I am pleased to introduce a new Altria Investor app for mobile devices and tablets. You can access this free app through the App Store and Google Play or through the scan code on the back of the presentation packet you received. You will find today's remarks and presentation both through the Altria Investor app and at altria.com.
Now, we will take your questions.
Thank you. Howard, I just wanted to walk through your guidance for 2014, specifically, if I am reading it correctly, I believe the fourth quarter assumes that you allow some of the benefit from the grower buyout expiration to flow through to the bottomline. So first, am I correct in that assumption? And if so, what's the risk that some of it could come back in the form of promotional activity just from the market? And also looking ahead, what would this imply for the first three quarters of 2015 as far as your planning right now?
Yes, I think the two things we pointed out about the fourth quarter is that the fourth quarter is the first quarter in which the $100 million quarterly savings from the end of the farmer price support program flows through. So there is $100 million cost reduction that ultimately is going to, on a roughly equivalent per pack basis, going to each of the players in the industry. And I think as we look at that, we think that is going to be a help to our earnings growth in the fourth quarter. And then I think the second factor that applies to us is that because of some tender refinance activity on our debt in the fourth quarter of last year, we had an elevated tax rate around 37% and we have projected a tax rate for this full year of about 35%. So those are two things that are going to likely enhance earnings growth in the fourth quarter that haven't been reflected in the first half results.
In the comments on the FDA, how realistic is that they take the objective sensible approach in terms of approvals on reduced-harm products? Or is it politically unviable and we should make that our base case?
I have to tell you this, at least our read of the FDA and how they have been reacting is that they have reacted the way we expected FDA to respond, which is they have focused quite a bit on the science and they have been deliberate and I think some would say that they have moved very quickly. But I think that's actually the way FDA tends to operate which is they focus on the science and they are careful and they move deliberately. I do not see that there has been a significant amount of political influence, okay. I think with regard to, okay, well what does that mean with regard to the final rule that comes out on e-vapor and other tobacco products.
I think that we have certainly gotten a bit of a read by their first proposal. But I would expect, given the thousands of comments they have gotten, that there is probably going to be some change in that proposal. We certainly are focused in areas that we thought would benefit reduced-harm product introduction, whether or not they are ultimately going to make those changes, I think we are going to have wait and see. But I don't think that it's been driven so much by politics. I think it's being driven more by the FDA following a careful science-based approach.
In your prepared remarks, you mentioned (inaudible) and the joint licensing with Philip Morris International. I was just curious if you had any sense of timing? When we looked at the burden of proof for the modified risk tobacco product approval process, it seems fairly high. So I was just curious, one, any sense of when we could see these products commercialized in the market? And just could you remind us, is this predicated on MRTP approval or is there the opportunity to commercialize it, and then get that modified risk status later?
Sure. And I think you are specifically referring to the heat-not-burn products that we have an arrangement with PMI to market it in the United States. And I think from our perspective, the two most exciting innovative tobacco products are e-vapor products and the heat-not-burn products and we think we are well-positioned through our own R&D investments or through the investments we share with PMI in both of those categories. But of course, the e-vapor products are almost $2 billion market in the U.S. today. And it is probably two to three years before there is any hope of FDA approving those products in the U.S. And then I think there is the further question of what type of claim they will allow on those products.
So while I think that the heat-not-burn products are exciting new products, they are a bit more in the three to five year time horizon in order to start reaping the benefits from that versus e-vapor that I think is small but rapidly growing today.
Got another question down front.
Given the incredible functional benefits of nicotine as a chemical, I mean Americans love caffeine and alcohol and marijuana and all those other things, nicotine also has a lot of functional benefits. What's your sense what does research say in terms of with greater reduced-harm products out there, what's the sort of nicotine penetration could go to in the U.S., well with that 20% or something now, what could it look like in the future if it wasn't, if you weren't smoking a plant?
Yes. I think the way I would think about that, which is the current focus of I think the industry with regard to innovative tobacco products, I think is squarely focused on current smokers. And I think there is certainly a hesitation on the part of many, including the FDA, to further spread the use of nicotine. But I think our view is that as more compelling e-vapor products come out that deliver against all the things that smokers are looking for, I think there is the opportunity for a pretty attractive potential future scenario with regard to even the focus on cigarette smokers in the e-vapor category. So I think we are not focused on expanding the category beyond the cigarette smoker base. And I think the current evidence is that the vast majority of e-vapor users are either current or recently former smokers.
You have talked about your SABMiller stake and the value of that asset. I was just curious if you could walk through it again, I know we have talked about this in the past but your thought process on SABMiller position, current market conditions and how maybe your thinking has evolved over the past four or five years on what you could potentially do with asset and how it would work for the shareholders?
Sure. To start off, we view that our core business is tobacco. We view that the SABMiller beer asset is a very nice and attractive financial asset. But I think that our aspirations from a core perspective remain with tobacco. I would say really since we acquired that position in SABMiller as a result of selling them the Miller Brewing Company business, we have consistently looked at that business with regard to how we could maximize the benefit to our shareholders. And that has caused us to, on a pretty regular basis consider a whole variety of options from monetizing it to considering supporting SABMiller in either making acquisitions or potentially in receiving acquisitions as well as hanging on to the stake and supporting the organic growth. And to-date we have felt very comfortable with the position of hanging on to that asset. And I think that is still our position. But it is not something that we take lightly. We do that analysis on a pretty regular basis. And I think we continue to feel very good about their future prospects. And I think it is something that we pay pretty close attention to. We have three seats on their Board. So we feel like were pretty well-positioned to have a say as their potential direction may change and we a lot of respect for their performance over the last many years.
Looks like we have one more up here again.
You mentioned on SAB as that it could be a source of liquidity. And I guess I am curious how you would monetize that in a tax efficient way?
Well, I think that is part of the challenge. I think there are certainly approaches that are more tax efficient than just selling the stock outright and paying the tax. But those tend to be complicated and they tend to apply in some respects for a lesser amount of stock rather than the whole thing. So that's something we are always analyzing. I think as we think about it as a potential source of liquidity, I think as we look at managing our balance sheet, we don't plan to need significant liquidity. But in the way we manage our balance sheet, we run right quite tight on the amount of cash on hand we have. As a matter of fact, right after we pay our tax bill and the MSA payment in April, our cash levels are quite low and we have actually got some borrowings in the commercial paper market in an average year. One of the reasons we feel comfortable doing that and paying out a large amount of cash to shareholders in dividends is twofold. We have got $3 billion revolver that backstops our commercial paper and cash needs. We have intended to draw on it, but it's there. And we also have the SABMiller stake which I would say is semi-liquid which also kind of backstops that. We haven't needed it in the past and I know we will need it in the near future, but it does give us some security with regard to our balance sheet.
Any closing questions?
And I think we will end it there. Please join me in thanking Howard and his team from Altria for their remarks today. Thank you.
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