Altria (MO, Financial)’s recent first quarter results contained little in the way of major surprises. Revenue net of excise taxes moved 1.8% higher to $4.67 billion, with a 4.2% decline in cigarette volumes being more than fully offset by price rises. Net income was 35% higher at $1.89 billion, with earnings per share moving 30% higher to 95 cents.
The transition of demand from smokeable products to smokeless tobacco has continued. The former saw revenue net of excise tax rise by 0.4%, while the latter’s growth in sales was 13%. Marlboro’s market share declined by 50 basis points to 43.2%, with the company’s overall market share down by 70 basis points to 50.3%.
Guidance for the full year was maintained. It anticipates mid-to-high-teens percentage growth in adjusted earnings per share for the full year. A continuation of the trend from smokeable to smokeless products is also expected – particularly as technology in the latter improves.
Catalysts
Confidence among investors regarding Altria’s future prospects seems to be relatively negative. The company’s share price is down by 25% in the last year as fears surrounding the future for the tobacco industry have gathered pace.
However, the potential for the company to deliver growth in reduced-risk product sales remains high. Around 3% of U.S. adults use products such as e-cigarettes, with them being popular among younger people. For example, 13% of high school students use e-cigarettes or other vaping devices. This ties in with a general trend towards consumers seeking less harmful nicotine-delivery products, with around half of adult smokers seeking to do so at the moment.
In order to strengthen its position within the reduced-risk product category, Altria is working on new products with Philip Morris. The latter’s IQOS heated tobacco system has enjoyed strong sales growth in overseas markets. In response, Altria has filed an application for sales approval in the U.S., which is pending with the FDA. Its approval could lead to a new growth opportunity for the company, with further technological innovation having the potential to allow it to capitalize on consumer demand for less harmful alternatives to smokeable products.
A "new" Altria
With growth seemingly focused on reduced-risk products, Altria has responded by putting in place a new business structure that is focused on the development of new products. Alongside the appointment of a new CEO, it has decided to split its business in two.
One part will be made up of its cigarette business, its U.S. smokeless tobacco business, as well as other tobacco products such as Middleton cigars and Nat Sherman. The other part of the business will include all of its reduced-risk products. The two parts of the company will have their own management teams in place. The aim of the restructure is to provide a faster pace of innovation, with the appointment of a chief growth officer signalling the company’s intent to identify the best growth opportunities in the reduced-risk product arena.
Risk
As mentioned, cigarette volumes continue to decline. Increased pricing is one reason for this, while consumer trends are another. Smoking in the U.S. hit an all-time low last year, with the proportion of adults who smoke now standing at 14% versus 16% in the prior year. Anti-smoking campaigns, higher cigarette taxes and smoking bans are some of the key reasons why cigarette usage is on the decline. This trend looks set to continue over the medium term, and could mean that even further price rises for the biggest-selling brand in the U.S., Marlboro, are eventually unable to offset the decline in sales.
However, demand for reduced-risk products could create a significant growth category for the company. Although 89% of the company’s sales are currently generated from smokeable products, the growth opportunity from reduced-risk products is significant.
For example, between 2014 and 2018, sales of e-cigarettes are estimated to increase from $1.5 billion to $3.6 billion per annum. This would represent almost 25% growth per annum. And with the potential for the IQOS heated tobacco product to be sold in the U.S. over the medium term and Altria’s focus on developing new products, the overall prospects for the business seem to be sound.
Verdict
The prospects for the wider tobacco industry appear to be uncertain at the moment. Declining demand for smokeable products means that the growth potential of the vast majority of Altria’s business is relatively limited. Price rises may offset volume declines over the near term, but it is not a sustainable growth strategy.
However, with the company having reorganized, it now seems to be in a stronger position to capitalize on the growth potential within reduced-risk products. They are becoming more popular among consumers, and this trend could be boosted by improvements in technology. Therefore, while the company’s outlook may be in the process of changing, its growth potential for the long term appears to be high. After its recent share price fall, there could be a value opportunity on offer.
