On Oct. 31, Altria (NYSE:MO) reported third-quarter results. Highlights include lowered long-term earnings per share guidance and an impairment charge on its JUUL Labs investment.
But don't be distracted by those headlines. Ample conservatism has been baked into Altria's forward guidance. And the news flow for the tobacco stock, which has been negative since summer, should improve from here.
Traditional cigarette volumes remain under pressure
During the third-quarter, revenues grew 0.3% and earnings advanced 10.2%, both in-line with estimates. Revenue growth continued to be positive as price increases more than offset volume declines. Industry volumes for traditional cigarettes fell 5.5% due to the secular decline in the category and smokers continuing to switch to e-vapor products, with each trend accounting for about half of the drop.
Altria's volume fell 7% as it yielded market share. Total market share dropped to 49.6%, down 60 basis points year over year.
While operationally the results were fine, management discussed the transformation occurring in the tobacco industry. A once predictable industry is now more dynamic as more users experiment with different products that have a perceived lower risk. Altria believes this trend will continue, and has spent significant time and resources developing a reduced-risk portfolio including IQOS (heated tobacco), JUUL (vaping), and On! (oral nicotine pouches).
Long-term guidance could prove conservative
Altria's long-term EPS guidance was adjusted down from prior guidance of 7% to 9% growth to a new guidance range of 5% to 8% growth. The new guidance range will allow Altria the flexibility to increase investment in its strategic platform of reduced-risk products and allow for slower near-term growth in the vaping category. Given the intense scrutiny that has surrounded the vaping category recently, the revised guidance certainly seems appropriate. However, while a number of vaping illnesses and deaths have emerged over the last six months, the Centers for Disease Control and Prevention said it believes the main culprit is the additive Vitamin E acetate. And importantly, JUUL has never used this additive in its products.
Altria also took a $4.5 billion impairment charge on its less than one-year-old $12.8 billion investment for a 35% stake in JUUL, the leading vaping manufacturer in the U.S. While appropriate given the current environment for vaping, investors should know that the current frenzy around the industry is overdone.
There are two main issues here. The first issue is the regulatory environment. The vaping industry will become a regulated industry in the near future in the U.S. This should actually be beneficial for Altria as many of the small, private players that lack the funding and regulatory experience won't be able to compete. The second issue is underage vaping. Here JUUL and Altria may have a more difficult road. But in the end, fines and marketing restrictions will be implemented, and perhaps negative headlines, but little more than that.
The product will remain on the market and will also likely return, over time, to many of the areas that have recently imposed bans. After all, other countries, such as the U.K., firmly believe in the reduced risk of vaping compared to smoking. In fact, the National Health Services (the system of public healthcare providers in the U.K.) and the Public Health England (an executive agency of the Department of Health and Social Care in the U.K.) both actively promote vaping as a safer alternative than smoking.
Altria is focused on financial flexibility and shareholder value
Management discussed its Anheuser-Busch InBev (NYSE:BUD) investment. Altria owns a 10.1% economic ownership in Anheuser-Busch InBev worth approximately $15.4 billion today. When an analyst asked about its ability to monetize the investment, Altria said when its lock-up period expires in 2021, it will reassess the investment. It also commented that with the recent tax law changes, its tax burden to liquidate the position is now significantly less than it was before. If Altria were to liquidate its stake in Anheuser-Busch InBev, management would have a meaningful chunk of cash to redeploy for the benefit of shareholders through potentially repurchasing stock, repaying debt or making additional acquisitions.
In another testament to Altria's focus on increasing shareholder value, it increased its dividend by 5% in August. This marked the 50th consecutive year of increasing its dividend at least once during the year. With a current dividend yield of 6.9% and long-term EPS guidance of 5% to 8% growth, investors should yield an annualized total return of close to 13% without factoring in any increase in the price-earnings multiple.
Altria's current price-to-earnings multiple is around 11x its projected 2020 earnings. This compares to a five-year average of 17.4x. Granted that average P/E is probably higher than it should have been as investors were into chasing yield a couple of years ago. But as visibility improves around the future for vaping, and investors gain confidence in Altria's strategy to transition to its reduced-risk portfolio, a higher multiple is certainly plausible. Applying 13x to 14x earnings to next year's consensus earnings of $4.41 yields a price target of around $60 per share. That implies upside of close to 30% on a total return basis.
Investors should take advantage of Altria before the smoke clears on the future of reduced-risk nicotine delivery products.