Is Altria Worried About the Future of Tobacco?

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The success of Altria Group (MO 1.91%) in producing impressive share-price gains is nearly unparalleled among stocks, even those with similarly long histories. Yet what's perhaps most impressive about Altria's business is how it has thrived from a financial perspective -- even as its core market has faced substantial challenges and downward trends. Recently, Altria CFO Billy Gifford spoke to attendees at the Barclays Consumer Staples Conference in early September. In his remarks, Gifford showed some insight into how Altria has navigated tough times and how it sees itself moving forward. Let's look more closely at Gifford's comments.

Dealing with falling cigarette volume

One of Altria's greatest threats has been the secular decline in smoking in the U.S., which has been a well-established trend for decades. Recently, Altria's business has done better than expected, showing signs of improving volume metrics that some optimistic investors heralded as potentially being a new normal for tobacco. Even the prospect for volume flattening out seemed like a big victory in some shareholders' eyes.

Yet Gifford didn't hesitate to quash hopes that there had been a true shift in falling cigarette volume industrywide. Noting low gas prices, a better employment picture, and a strong housing market, the Altria CFO pulled no punches in describing his view of the future market:

In 2015, the overall industry volume was roughly flat. ... We were asked a lot about that flat volume, and "Hey, is this a break in trend?" And we were looking at those factors that make up that volume decline -- prevalence, secular decline, those types of things -- and we weren't seeing those factors change. And we kept letting everyone know that a long-term trend seems to stand that we would predict that it would be down 3% to 4% through time. It was just a matter of time on how long it took to get back to that. And I think we're starting to see overall industry volumes move back in that direction.

Clearly, that's not the news that investors would like to hear. However, it's important to understand that Altria has done an extremely good job in finding ways to keep its volumes from falling as much as the industry average. Through important strategic moves like its emphasis and optimization of its Marlboro brand, Altria has been able to keep loyal customers coming back to its products, keeping market share high and claiming as much of the cigarette market as it can. Those efforts will remain important as volume falls.

Planning for whatever the future brings

In the face of an ongoing secular decline in cigarettes, Altria has joined the movement in looking for alternatives to traditional cigarettes that could spur future growth in the tobacco industry. So far, those efforts have produced innovative results that could take the company in any of several directions.

On the one hand, Altria is excited about its e-vapor product, MarkTen XL:

The approach we've taken with MarkTen XL, to describe [our] discipline, is we really wanted to be where e-vapor volume is. And so we're in approximately 44,000 stores, and we've been methodically expanding that through time.

Yet more importantly, Altria isn't placing all of its bets on one particular type of alternative tobacco product. The company has been involved in the iQOS system, and it sees the potential for the system's heat-not-burn technology to produce a different experience from most e-vapor products. Again, in Gifford's words:

When we think about innovative tobacco products, we think about it as a portfolio approach. E-vapor is one piece of it. iQOS will be the second piece of it. And so it's really about providing our consumer who wants something as an alternative with a portfolio of products to let them decide where they want to land.

Of course, a lot of the potential for Altria's alternative products will depend on how they end up getting regulated. Going through the process with the U.S. Food and Drug Administration on iQOS will be vital in getting that product line moving well, but with both it and e-vapor products, Altria will almost certainly have to deal with requirements and restrictions on how it markets and commercializes cigarette alternatives.

Maintaining a balanced approach

Altria certainly isn't giving up on its popular cigarette brands, and it knows that it has to make the most of its valuable traditional tobacco franchises as long as it can. However, by looking at alternatives, Altria will keep its options open to make sure it doesn't get left behind if the market moves more sharply in that direction.