Altria Group: Demographics Are Destiny

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About: Altria Group, Inc. (MO), Includes: PM
by: Dividend Latitude
Summary

America’s Smoking Demographics are Changing.

Altria is navigating new technology in Nicotine Delivery.

Summary: My outlook as a MO investor has changed, based on this analysis.

America’s Smoking Demographics are Changing

Demographics is the study of human populations and population groups, and how those groups are projected to trend with time. What do demographics tell us about the future of adult smoking in America? A 2018 press release from the Centers for Disease Control and Prevention ("CDC") informs us:

“Overall, cigarette smoking among U.S. adults (aged ≥18 years) declined from 20.9 percent in 2005 to 15.5 percent in 2016. Yet, nearly 38 million American adults smoked cigarettes (“every day” or “some days”) in 2016….”

Source: Smoking is down, but almost 38 million American adults still smoke

This rate of decline is not likely to change much, over the course of a decade or less, barring a significant trend disruption or two. I discuss this in the next section.

Using the implied rate of decline from the CDC, and population projections for the years ahead, we can estimate the number of adult smokers in the US at a future date. Warning! Math ahead.

From the CDC data above, and using an identical time frame of 11 years elapsed (2005 to 2016), I estimate the percentage of adult smokers in 2027 (11 years from 2016) to be 11.5%.

Why? Well, in 2005 the adult smoking rate was 20.9%. In 2016 the adult smoking rate was 15.5%. That is a reduction of (20.9-15.5)/20.9 = 25.8% in 11 years.

Using that reduction rate, I project 74.2% x 15.5% = 11.5% of adults will be smoking in 2027.

How many people will this be? To estimate, I found a population pyramid for the good ol’ US of A in 2027:

Image Source: Population Pyramids of the World from 1950 to 2100

In 2027 our total population will be about 349.5 million. Summing the first 4 age cohorts in the pyramid shows that the 0-19 age group will constitute 24.4% of them. Now I will correct for the likelihood that the national smoking age will be 21 by the year 2027. Source:

Supporting 21 as the Legal Age to Purchase Tobacco Products - Altria

I estimate the 0-20 age group will be (20/19) x 24.4% = 25.7%. Thus the number of adults will be 74.3% x 349.5 million = 259.7 million. The number of them who will be smokers is about 11.5% x 259.7 million = 29.9 million smokers.

In short, the CDC said we had almost 38 million smokers in 2016, and the demographics project almost 30 million smokers in 2027.

That is still a lot of smokers! I did not expect that. Did you? The math and the demographics yielded a surprising result. Note: This result includes the loss of smokers who converted to vaping from 2005 to 2016.

Barring a trend disruption, Altria’s customer base is not collapsing – far from it. But is there disruption happening now?

Altria is navigating new technology in Nicotine Delivery.

Tech disruption? Say it’s not so! And actually it may not be so.

Most smokers don’t want to quit nicotine. They just don’t want the adverse health impact related to the harmful compounds in tobacco. In response, Altria is now delivering nicotine to its customers with three potential disruption vectors. These are e-vapor or “vaping”, “heat not burn”, and tobacco-free oral nicotine pouches (On!).

In vaping, legacy cigarette companies were the early movers. Yet latecomer JUUL left them all in the dust. This young company is looking more and more like the Amazon of vaping! They are acquiring nearly 100% of all new e-vapor volume growth in the US (slide 18):

Altria Group, Inc. 2019 Q2 - Results - Earnings Call Slides

Seeing an existential threat to the primary business, Altria recently acquired 35% of JUUL. The downside to having a minority stake is when MO loses a smoker to JUUL, they lose 100% of that individual’s tobacco business and recoup only 35% of his/her vaping business.

But there is a tremendous upside - JUUL can expand worldwide! Given there are about 1 billion smokers globally, the potential upside vastly outweighs the potential downside in the US, with its ~37 million smokers.

How is the international roll out progressing? From the latest MO earnings conference call transcript we learn:

“Internationally Juul continues to make progress expanding to additional markets. Since April Juul launched in several new markets which include Ireland, South Korea, Austria and the Philippines. Juul plans to launch additional markets by the end of this year, it's still early days for Juul international distribution”

Source: Altria Group, Inc. (NYSE:MO) CEO Howard Willard on Q2 2019 Results - Earnings Call Transcript

In other words, it’s too early to tell how JUUL will perform outside the US. If it’s anything close to what happened domestically, expect something big.

Vaping is rightly viewed as a threat to Altria’s core business of combustible tobacco products. Obviously the risk would be lessened if Altria could retain a higher percentage of a smoker’s business when they quit smoking. And now they (probably) can, with the roll out of IQOS.

Image source: ECigIntelligence, Regulatory & market intelligence for e-cigarette market

IQOS is an invention of Phillip Morris, the international distributor of Marlboro brands, in the “Heat Not Burn” ((HNB)) technology category.

This device delivers nicotine by heating a tobacco plug (a HEET stick) to volatize the nicotine within, while delivering much less of the harmful compounds in smoke. HNB simulates the smoking experience much more closely than vaping does, by providing the user with tobacco flavor.

IQOS has been available outside the US for a few years now, and is showing the potential to be a game changer in stabilizing shipment volumes of tobacco sticks for PMI, as shown in their most recent conference call.

Source: PM earnings slide deck

In April of this year, the US FDA approved IQOS for sale in the US, and Altria is the sole licensee of this technology. They will start selling to the public next month. So far I haven’t seen a breakdown of what IQOS will cost Altria. Presumably, their cut will be far greater than the 35% fraction that they own in JUUL.

But the most critical factor to me, again, is the potential to slow the rate of volume loss in tobacco stick sales, or even stabilize it.

Summary: My outlook as a MO investor has changed, based on this analysis.

The key take-away from the CDC data (and thus my demographic projection) is this: It already includes the reduction in smoking due to vaping switch rates, from 2006 to 2015.

Of course, this data is from before the advent of JUUL, but it isn’t as if the data includes none of the smoking decline caused by vaping. Even with JUUL around, it is possible, maybe probable, the US will have nearly 35 million adult smokers in 2027. The number of adult smokers is far from collapsing.

Since JUUL is getting nearly 100% of all new vaping business in the US (according to Altria), there is currently no additional vaping disruption on top of what JUUL creates.

If JUUL’s disruption rate continues, then Altria’s 35% stake in JUUL has immense upside potential, due to international markets being open for JUUL. This could more than offset the US revenue loss to JUUL.

IQOS appears to be stabilizing sales volumes for PMI. Now Altria has the opportunity to sell it in the US under license.

For me, nothing works as well as cold, hard numbers to clarify an investment thesis. After doing the analysis, I consider myself optimistic about Altria’s business for the next decade. I rate MO stock a “buy” at this time. Thank you for reading!

Disclosure: I am/we are long MO, PM. 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.