PM USA estimates that total cigarette industry volume declined approximately 4% in the first quarter. For the full-year 2008, PM USA estimates a total cigarette industry volume decline of approximately 3%.
Altria Group’s (NYSE:MO) tobacco manufacturing and distribution business, PM USA expects this trend to continue, with industry shipment volume declining 2.5% - 3.0% annually over the next few years.
So, why would anyone own Altria Group?
I do, and here’s why:
Altria dominates the U.S. tobacco industry with powerful brand names. The company has a commanding 50.9% share of the cigarette retail market. Marlboro boasts a 41.5% share. Acquired last December, John Middleton placed Altria in a leading position in the machine-made large cigar market with a 26.8% share. Middleton’s key Black & Mild brand controls 25.9% of that market.
Altria has a fortress balance sheet with lots of cash and low debt. The company ended this year’s first quarter with $4.8 billion in cash and cash equivalents, and long-term debt as a percentage of total capital of 13.5%.
Altria has always been and still is a cash machine. Right out of the box post spin-off the company delivered free cash flow of $1.9 billion in the first quarter.
Management is implementing a strategy that should support earnings growth in a shrinking market. The strategy calls for: cutting expenses at rates that exceed declines in cigarette volume; growing market share; and extending product lines and leveraging distribution through acquisitions and internally developed products.
Here’s how the company is performing so far:
- Management plans to slice $1 billion out of the company’s cost structure by 2011. Selling, general and administrative expenses will drop by $600 million. Corporate headquarters functions have been restructured, including the relocation to Richmond, Virginia from New York, and should yield annual savings of $250 million starting next year. Another $156 million will come from the closing of the Cabarrus, North Carolina manufacturing facility and subsequent consolidation with the Richmond, Virginia facility by 2010.
- Market share grew in the first quarter from a year ago. The company’s share of the cigarette retail market gained 0.5% on the back of Marlboro’s 0.7% increase.
- John Middleton is in a segment of the industry that’s growing 4% - 5% per year. Middleton posted a first quarter volume gain of 8.2% with Black & Mild increasing its market share by 3 points.
- New products have not worked out so well. Marlboro Ultra Smooth, a high tech filter cigarette, was recently pulled from the marketplace due to low acceptance. Other failures include a cigarette with a battery-powered holder to heat the tobacco, and a spit free chewing tobacco. I believe that shareholders would be better served if management would abandon this part of their strategy and redeploy these resources on what they know and already are doing best.
- Altria has started 2008 with a solid earnings performance. Earnings per share (adjusted for one-time items and from continuing operations) came in at $0.37 in the first quarter, up 12.1% from the same year earlier period on a 2.8% gain in net revenues. Management affirmed their forecast for 2008 earnings per share at $1.63 - $1.67, for an increase of 9% - 11% off of a 2007 base of $1.50, and set an objective of growing earnings 8% - 10% over the next few years. Projections by Street analysts are at the high end of these ranges.
Altria has a 28.6% ownership interest in SABMiller, the world’s largest brewer. At the end of the first quarter, Altria’s investment in SABMiller was carried on the books at $4.1 billion and had a recent market value of nearly $10 billion.
The company is returning cash to shareholders. The Board of Directors set the initial quarterly dividend at $0.29 per share, and is targeting a 75% payout ratio. They also approved a $7.5 billion share repurchase program to be completed over 2 years. The company began buying back shares in April.
Altria’s shares are attractively valued with a price / earnings ratio and yield that compare favorably with the S & P 500. The shares’ price / earnings ratio, at 12.9x 2008 earnings per share of $1.63, is below the S & P 500’s 14.5x based on S & P’s earnings estimate of $88.04 for this year. The shares also offer a fat 5.5% yield, well above the S & P 500’s 2.4%.
Disclosure: I own Altria