Altria Group's (NYSE: MO ) stock traded down 2% in the hours following the release of its fourth-quarter earnings results on Thursday morning. Earnings and revenue came in below analysts' expectations, sending investors scurrying for the exits. Even though one quarter does not make or break a company, Altria's fourth-quarter results have important implications for long-term investors.
Breaking down the earnings release
Altria reported $0.57 in adjusted earnings per share for the quarter, bringing its fiscal 2013 adjusted EPS to $2.38 -- a 7.7% increase over 2012. Management estimates the company will earn between $2.52 and $2.59 per share in 2014 (adjusted for special items) -- a 6% to 9% increase over 2013.
Altria's fourth-quarter EPS came in $0.01 below consensus expectations, and analysts had estimated 2014 earnings of $2.58 per share -- at the high end of management's guidance.
The most disappointing aspect of Altria's fourth quarter is the Marlboro volume declines. Investors had reason to be hopeful that Marlboro shipment volume would stay even in the quarter because volume increased 1.5% in the third quarter despite steady declines in prior quarters. However, Altria shipped 5.7% fewer Marlboros in the fourth quarter to end the year with 4.3% fewer Marlboros shipped than in 2012.
Marlboro's declining volume is not the result of consumer rejection of its brand or of mismanagement; Marlboro actually gained market share in the fourth quarter and now accounts for 43.7% of U.S. retail sales of cigarettes. The decline is just a continuation of industrywide cigarette volume declines driven by higher taxes and increased public awareness of the dangers of smoking cigarettes.
U.S. cigarette volume declined 3% in 2012. Altria's overall cigarette volume fell 5.8% but increased its share by 0.3 percentage points. That its volume declined and market share increased suggests that the overall cigarette market declined by even more than Altria's volume. If this is the case, then cigarette volumes have resumed a steep descent after having slowed in prior years.
However, Altria has historically been able to offset volume declines by increasing prices. Marlboro, which accounts for the vast majority of Altria's cigarette revenue, is a premium brand that has a fair degree of pricing power. Altria's fourth-quarter revenue from smokeable products decreased just 3.2% compared to a 5.7% volume decline. Moreover, its profit increased 4.5%. Most of this performance is attributable to higher prices for Marlboro cigarettes.
Capital structure changes
Altria's unadjusted earnings per share declined by 56% due to a loss on the early retirement of debt. The company repurchased $4.1 billion of debt and replaced it with $3.5 billion of debt at a lower interest rate. Altria was able to lower its weighted average interest rate from 7.2% at the end of 2012 to 5.9% at the end of 2013. This enables the company to pay lower interest and thus higher dividends.
Altria announced a $0.48 quarterly dividend -- $1.92 for the full year. That is about 75% of management's 2014 earnings guidance, slightly below its stated payout- ratio target of 80%. If earnings trend toward the high end of management's guidance, Altria may hike the dividend in Q3 or Q4.
Marlboro does not have unlimited pricing power, and cigarette volumes will continue to decline. Eventually, Altria's smokeable products' profit will decline. As a result, the company must find another avenue to grow earnings if it wants to justify its current market valuation.
E-cigarettes may be that growth avenue, but Altria is far behind its competitors in this market. Lorillard already commands a 49% share of the e-cigarette market with its popular blu e-cigs, and Reynolds American is beginning the national rollout of its Vuse e-cigs after testing them in Colorado. Altria's MarkTen e-cigs, meanwhile, just expanded into Arizona in the fourth quarter and the company has not yet set a date for a nationwide rollout. If the company expects to capture a meaningful share of the only major growth opportunity in its industry, it needs to increase its urgency to enter the market.
Investors should keep a close eye on Marlboro pricing and MarkTen expansion; Marlboro will need to keep growing profits long enough for MarkTen to come to market, otherwise Altria shareholders could be in trouble.
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