Cigarettes are the bread and butter of Altria Group (NYSE:MO), and the company gets a huge portion of its overall revenue from sales of Marlboro and other key brands. But when it comes to segment performance and growth, smokeable products haven't been the leading area for Altria. Instead, Altria's fastest-growing segment has been smokeless tobacco products, and a huge part of the gains there have been due to the success of the other major brand in Altria's arsenal: Copenhagen.

Altria's U.S. Smokeless Tobacco Company unit has a long history. Image source: Altria.

How smokeless tobacco is getting a growth boost

It's easy to understand why many Altria investors essentially ignore the tobacco giant's smokeless products segment. The unit produces less than a 10th of the revenue that the cigarette division brings in, and the vast majority of Altria's profit also comes from smokeable products.

However, when you look at results from the first nine months of 2016, Altria's smokeless unit has dramatically outperformed its rival segment. Revenue net of excise tax is up more than 10% from year-ago figures, and adjusted operating company income has climbed an even more impressive 13%. Compare that to corresponding figures of 2% revenue growth and a 6% rise in adjusted OCI for the cigarette business, and the extent of Altria's smokeless success is even clearer in context.

Part of the reason why Altria is excited about smokeless tobacco is that the segment has two financial advantages over the cigarette division. First, the amount of excise tax that Altria has to pay on smokeless products makes up a smaller fraction of its sales, at less than 7% so far in 2016 compared to 27% for the smokeable products division. In addition, Altria is able to hold onto more of its revenue in the form of operating profit for smokeless products, boasting an operating margin of 66% compared to 49% for the cigarette unit.

Operationally, gains for smokeless tobacco have been more significant as well. So far this year, shipment volumes for smokeless products have jumped by 6%, with Copenhagen leading the way with a nearly 12% boost compared to 2015 levels. That compares to a 1.6% decline in shipment volume for smokeable products, with the key Marlboro brand seeing shipments fall by almost 2%.

Copenhagen keeps leading the way

For Altria, smokeless tobacco success has been almost exclusively due to the strength of the Copenhagen brand. The brand's retail share climbed to 33.6% this year, up by more than 2 percentage points since last year. That helped drive overall share for Altria's smokeless tobacco division to 55.6%, and that's even better than roughly 51% market share that Altria cigarette brands command in the smokeable segment.

Indeed, were it not for Copenhagen, Altria's smokeless tobacco division would be in a much different place. Fellow snuff brand Skoal has seen shipment declines and market-share losses that have offset some of Copenhagen's gains, and the other products that Altria sells have also seen falling volume and share.

In response, Altria has put most of its efforts in smokeless tobacco toward promoting Copenhagen's popularity. Flavor concepts have been big winners for the company, and after the success of its Wintergreen product, the recent release of Copenhagen Mint has gone well. By identifying areas of the market where consumers have already demonstrated an interest, Copenhagen is tapping into already-existing demand and using the power of its brand loyalty to retain current Copenhagen users and to bring users of rival products into the Copenhagen fold.

Given the size of Altria's various business segments, many investors will never pay much attention to anything beyond its cigarette lines. But Altria has learned valuable lessons from its success with Copenhagen and the rest of its smokeless products, and those lessons could well filter into other parts of its business in the future.

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