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Stability and Earnings Growth Are Hallmarks of Altria’s Performance

Altria Group (NYSE: MO  ) dominates the U.S. tobacco market; the company has a domestic market share of almost 50%. Marlboro remains the company's flagship brand, and the company generates solid cash flows, has visible earnings growth, and offers impressive cash returns to shareholders. Altria has been relying on price increases to drive revenue growth as sales volume for conventional cigarettes declines. The company has been taking steps to mitigate the impact of dropping sales volume by strengthening its smokeless products portfolio and increasing its promotional spending.

The market share of the smokeable segment continues to grow
Pricing is likely to remain key to Altria's revenue growth, as sales volume is declining because of tax hikes, demographic changes, and tighter regulations. In the present industry environment, the company has been doing well by moving forward and growing its earnings per share. Price increases, cost cuts, share buybacks, and the strengthening of its product portfolio remain among the important tools used by the company to grow earnings. In the first quarter of 2014, the company reported adjusted EPS of $0.57 and total revenue of just over $4 billion, which represent year-over-year increases of 5.5% and 0.9%, respectively.

In the first quarter of 2014, the sales volume of the company's flagship brand Marlboro was down 2.4% YoY, consistent with the industry trend. Total cigarette volume for Altria was down 3.5% YoY, better than the volume declines of Reynolds American  (NYSE: RAI  ) and the domestic industry at 5.2% and 4%, respectively, for the first quarter of 2014. However, Lorillard's (NYSE: LO.DL  ) sales volume decline of 1.8% outperformed the industry's volume trend in the recent first quarter.

Even though Altria experienced a volume decline in the first quarter, its domestic retail market share and that of the Marlboro brand each grew by 20 basis points. Moreover, the net revenue and operating income of Altria's smokeable segment were up 1.2% and 6.4% YoY, respectively. Also, Lorillard and Reynolds also experienced YoY market share gains of 30bps and 10bps. Even though volume for the domestic industry declined, the market share gains of the three leading U.S. tobacco companies could be early signs of an improvement in consumer spending and signal consumer preferences moving away from private label brands.

The tobacco companies make efforts to diversify their product portfolios
With volumes of conventional cigarettes challenged, Altria has been making continuous efforts to diversify its product portfolio toward smokeless and alternate tobacco products, and it seems to be making progress with these initiatives. The performance of the company's smokeless segment remained solid, driven by the Copenhagen brand, which was slightly offset by a weakness in Skoal.

Copenhagen's volume was up 11% and it also reported a retail market-share gain of 1.5%, whereas Skoal's volume dropped by 0.6% in the quarter. The segment enjoyed net revenue growth of 6.4% YoY and adjusted operating income growth of 7.7% YoY in the quarter. Copenhagen and Skoal together enjoyed 0.20% growth in retail market share as their share increased to 50.8%.

In the upcoming quarters, volumes for the smokeless segment are likely to improve further because of the company's promotional spending, which is consistent with its brand building measures. Also, the launch of the e-cig Mark-Ten by Altria this month will positively affect revenue and help the company diversify its portfolio away from conventional cigarettes. However, promotional spending and investments related to the roll-out of Mark-Ten could drag on earnings in the short term.

Reynolds has also been taking aggressive initiatives to diversify its product portfolio away from conventional cigarettes to keep up with the changing industry trends. The performance of Reynolds' American Snuff (smokeless) segment remained solid, as the segment's revenue was up almost 10% while profit was up 9.5% YoY in the first quarter of 2014, and this partially offset a weakness in the RJR (smokeable) segment.

Also in the quarter, Reynolds' Santa Fe segment enjoyed revenue and adjusted operating profit growth of 17% and 25%, respectively. As Altria is likely to ramp up its promotional spending, consistent with brand building efforts for its smokeless segment which will focus on Skoal, Reynolds is also likely to respond by increasing promotional spending and this will positively affect volumes for both companies; however, this could keep earnings under pressure in the short term.

Lorillard has registered dominance in the e-cigs market, as it currently has a domestic e-cigs market share of 45%, up from 35.3% in the first quarter of 2013. Lorillard successfully strengthened its e-cigs portfolio through the acquisition of blu eCigs, the leading e-cigs company in the U.S., on April 24, 2012. This was followed by the acquisition of SKYCIG, a U.K.-based e-cig business, on October 1, 2013. To further strengthen the performance of its e-cig segment, Lorillard is in the process of rolling out blu eCigs in the U.K. this summer.

Final words
Altria continues to dominate the U.S. tobacco market. The company offers stable earnings growth. Despite the challenging sales volume trend present in the domestic industry, the company continues to grow its market share. Also, Altria has been making successful efforts to diversify its portfolio away from conventional cigarettes and the performance of its smokeless segment remains solid, which likely augurs well for the long term.

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Furqan Asad

Furqan Asad mostly writes for the Consumer, Energy and Utility sectors. He has extensive experience in research and analysis and rigorous academic training from prestigious schools including London School of Economics. Furqan Asad has also passed all three levels of the CFA exam.

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