Altria Posts A Fantastic Second Quarter

Jul.29.12 | About: Altria Group, (MO)

Cigarette maker Altria (MO) reported excellent results Tuesday. Adjusted earnings per share for the second quarter increased 9.3% to $0.59, $0.02 higher than the consensus estimate. Revenues also outpaced expectations, growing 9.6% to $6.5 billion-about $2 billion north of what consensus had predicted. Net of excise taxes, revenue grew at an even more impressive pace of 14.4%, to $4.6 billion. The Marlboro brand name remains strong, and we think shares have modest valuation upside from current levels.

Perhaps the most telling data point out of Altria's second quarter report was the firm's ability to grow revenues in spite of declining cigarette volume. Shipments of Marlboro cigarettes, by far Altria's largest brand, fell 0.8% to 31.3 billion sticks, while other premium brand shipments fell 8.4% to 2.3 billion sticks. Though discount stick shipments increased 24% year-over-year, aggregate cigarette shipments only grew 0.1% on a year-over-year basis, meaning Altria has been able to successfully raise prices and retain its brand loyalty. The firm's market share increased 0.8 percentage points from the same period last year, to 50.3%.

Even if it may seem clear that domestic cigarette smoking is in long-term decline, we think worries are slightly exaggerated. According to the Center for Disease Control, it appears that smoking among teens is declining at a slower rate than it did at the beginning of the millennium. Since cigarette smoking is addictive, youth smoking trends are a fairly good indicator of future cigarette consumption, in our view. We believe that in the United States, facts about the dangers of smoking are transparent and well distributed, so we see no reason why any decline in smoking would suddenly accelerate (unfortunately for the public's health but fortunately for Altria's business prospects).

In addition to strong performance from its cigarette brands, the firm's smokeless tobacco division continues to grow. Altria owns brand leaders Copenhagen and Skoal, and the segment grew revenue 5.4%, to $426 million. Unlike cigarette volume, smokeless tobacco volume grew 7.6% on a year-over-year basis. Due to arguably less prevalent use, smokeless tobacco hasn't been the same punching bag that cigarettes have been. However, it may eventually encounter the same scrutiny as cigarettes, but we expect the segment to continue to grow at a decent clip in the near-term.

Though Altira doesn't have exposure to higher international growth markets--like Phillip Morris (PM), for example--we think the US cigarette business remains relatively resilient. The company's ability to pass on cost increases to its customers and continued dedication to returning cash to shareholders remains on display. The cigarette business requires very little incremental investment, so the tremendous amount of free cash flow the firm generates will be used to reward shareholders. We love the firm's 4.7% annual dividend yield, and we believe there is an excellent chance the company continues to grow it at a nice pace going forward. We continue to hold the firm in our Best Ideas Newsletter portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: MO is included in our actively-managed portfolios.