Ride Altria Higher By 2013

| About: Altria Group, (MO)

Altria's (NYSE:MO) results for the third quarter of 2012 show that net revenues increased 2.2% to $6.2 billion, mainly because of higher net revenues from smokeable products. For the first nine months of 2012, net revenues increased 4% to $18.4 billion because of higher net revenues from financial services and smokeable products. Revenues net of excise taxes rose 3.2% to $4.5 billion for the third quarter of 2012, and 6.2% to $13.0 billion for the first nine months of 2012. Comparisons of Altria's nine-month net revenues and revenues net of excise taxes for 2011 were affected by a charge related to certain PMCC-leveraged lease transactions, which reduced 2011 nine-month net revenues by $490 million. The company's adjusted diluted EPS, excluding certain special items, increased 3.6% to $0.58 a share for the third quarter of 2012 and 7.8% to $1.66 a share for the first nine months of 2012. The consensus estimate for revenues for the quarter was $4.4 billion.

The net revenue for the smokeable products segment grew by 2.1% year over year to $5.6 billion, mainly because of positive pricing and higher volumes partly offset by higher promotional investments. Revenues net of excise tax rose by 3.2% to $3.9 billion. Adjusted operating ' income increased 4.3% year over year to $1.64 billion, as a result of better pricing and improved cost management in the company. Shipment volume in the quarter went up 1.1% to 34.0 billion sticks compared with the prior-year quarter, boosted by a 1.2% increase in cigarette shipment volume and partly offset by a decline in cigar volume. Smokeless products net revenue increased 2.6% to $437 million on the back of higher volume and better pricing. Revenues net of excise tax went up 2.5% to $408 million.

Adjusted operating income increased 3.3% year over year to $254 million. Third-quarter shipment volume went up 5.9% to 194.3 million units because of volume growth in the Copenhagen and Skoal brands. Wine segment net revenue surged 6.1% to $140 million in the quarter, while revenues net of excise tax rose 6.3% year over year to $145 million. Adjusted operating income went up 8.3% to $26 million because of higher shipment volume, improved product mix, and higher pricing. Wine shipment volume grew by 3.7% on the back of expansion in off-premise channels. Financial services reported adjusted operating income in the third quarter, which declined 4.8% to $79 million.

Altria's cost reduction program remains on track and is expected to deliver annual cost savings of $400 million by the end of 2013.The company estimates that total net pre-tax restructuring charges in connection with this program will come to approximately $300 million consisting primarily of employee separation costs of approximately $220 million and other associated net costs of $80 million. In September 2012, Altria completed a tender offer for $2.0 billion consisting of the repurchase some of its debt. This debt repurchase resulted in a pre-tax charge of $874 million against 2012 third-quarter earnings, reflecting the loss on early extinguishment of debt related to the tender offer. As a result, the company was able to replace high-cost debt with low-cost debt, resulting in long-term interest savings and a more favorable debt maturity profile.

The board of directors voted in August to increase the regular quarterly dividend to $0.44 per common share compared to the previous rate of $0.41 per common share, an increase of 7.3%. The current annualized dividend rate is $1.76 per common share, which works out to an annualized dividend yield of around 5.4%. Altria expects to continue to return a large amount of cash to shareholders in the form of dividends by maintaining a dividend payout ratio target of approximately 80% of its adjusted diluted EPS. In addition, the company repurchased shares worth approximately $262 million in the quarter. Altria's board has authorized the expansion of the current share repurchase program from $1.0 billion to $1.5 billion. The company has approximately $550 million remaining in the expanded program, which it expects to complete by the end of the second quarter of 2013.

Altria has a 50% share of the U.S. cigarette market in terms of volumes are ahead of competitors like Reynolds American (NYSE:RAI), Lorillard (NYSE:LO), and Philip Morris International (NYSE:PM). The cigarette market in the U.S. is declining and the company has to rely on pricing to grow revenues. However, the smokeless products segment has performed well and could play an enhanced role in driving revenue growth. The market for smokeless products is relatively new, and a large segment of consumers consist of smokers who are switching to what they believe is a less harmful alternative. Smokeless products also pay lower excise duties, which make them cheaper. Another major factor in Altria's top-line growth in coming quarters is the recent ban on graphic warning labels imposed by a federal appeals court, under which cigarette companies in the U.S. will no longer be required to place such images on their packs. Because cigarette companies are not allowed to advertise and market their products, they have been unable to offset the damage caused by carrying these warnings.

At the end of the day, people are hardly going to give up smoking and Altria has shown a most impressive ability to continue to squeeze improved profitability out of the declining cigarette market by using a combination of pricing, volume growth, and cost management. This is certainly a sustainable strategy as long as smokers are willing to pay more. In the absence of growth, the company has also adopted a sensible policy of rewarding investors with dividends and share repurchases. Unless you have moral qualms about buying so-called "sin stocks," this is one of the most compelling income investments because of the roughly 5.4% dividend yield. Altria is currently trading around $31.76, and I think the stock will maintain the $35 to $36 price level by 2013. In my opinion, the dividend is sustainable in the foreseeable future. If you are looking for an income investment, I strongly recommending Altria.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.