Altria Group's (NYSE:MO) stock price opened 1% lower Tuesday after releasing its second-quarter earnings report. The U.S. distributor of Marlboro cigarettes posted 5% earnings-per-share growth, but declining cigarette volume led to a slight revenue decrease. The company's ability to raise prices while retaining market share is crucial to shareholders' long-term returns. So, did Altria follow through this quarter?

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Image courtesy Altria Group

Strong quarter relative to industry
Altria reported $0.65 adjusted diluted EPS for the second quarter, up 4.8% from the same quarter in 2013. For the full year, management raised the lower bound of its guidance by $0.02 and now expects EPS to come in between $2.54 to $2.59, a 7% to 9% growth rate. The higher guidance is due to Altria's strong performance in the first two quarters of the year and because "the risk of anything upsetting [Altria's strategy this year]...has passed now." There is nothing on the horizon that could upset another solid year of EPS growth.

Unfortunately, cigarette volume declined more than usual. Total industry cigarette volume declined 4.5% in the quarter, while Altria's volume declined 4%. The 4.5% decline is larger than usual – Altria estimates that the industry averaged a 3.5% decline over the last three years – but the number is volatile. One quarter's decline is not enough to conclude that the market is deteriorating.

Moreover, Altria gained market share while raising prices – indicating that its pricing power remains intact. The company gained 20 basis points in cigarette market share, although most of the gains came from discount cigarettes. At the same time, income from smokeable products – which also includes cigars – increased 3.6% in the quarter. Altria achieved this by raising prices, thus expanding its smokeables margin by 1.2 percentage points to 44.2%. Altria needs to retain its ability to expand its profit margin if it hopes to continue growing earnings amid the declining cigarette market.

E-cigarette expansion
Altria's e-cigarette business is a big wildcard that could unleash upside for the stock. The company began rolling out its MarkTen e-cigarette brand in the western half of the U.S. last month. The brand is already in 60,000 stores – 40% of blu eCigs' retail footprint – which sell about 70% of cigarette volume in the region. In other words, MarkTen is now available for 70% of the western U.S. market just one month after launching. The company will be rolling eastward as the year goes on, so MarkTen's retail footprint could soon rival blu eCigs'. Once you add in the potential of Green Smoke, you discover that Altria has something going in the e-cigarette market.

Housekeeping items
In addition to getting vital information on cigarette volume and the MarkTen rollout, investors wanted to hear CEO Marty Barrington's thoughts on the recently announced merger between the No. 2 and No. 3 U.S. tobacco companies. Unfortunately, Barrington declined to comment on the deal, saying, "I am not going to comment on a transaction that's been proposed by others.."

Fortunately, Barrington had more to say on other items, such as Altria's dividend and new share repurchase program. He noted that Altria's 4.6% dividend yield far exceeds the average S&P 500 yield (2%) and the 10-year Treasury yield (2.5%.) He also indicated that Altria would maintain its 80% payout ratio target.

Moreover, Altria's board authorized a new $1 billion share repurchase program that it expects to complete by the end of 2015. It has $53 million remaining under the previous repurchase program as well. If Altria uses its entire repurchase authorization over the next six quarters, it will roughly equal the repurchases made over the last six quarters. This is good news for shareholders focused on higher dividends and earnings per share in the years ahead.

Foolish takeaway
A faster-than-normal cigarette volume decline is not yet concerning, but investors should keep an eye on it to see if it becomes a trend. Fortunately, Altria's pricing power enables it to continue growing earnings even when volume declines by more than is expected, giving shareholders significant downside protection. Moreover, MarkTen's e-cigarette rollout offers investors upside if it can establish a leading position in the U.S. market. As a result, it is hard to conclude that this quarter was anything but an affirmation of Altria's quality as a long-term investment.


Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.