MO – Price Taking Negates Steep Volume Declines

Altria grew Q2 adjusted diluted EPS +4.8% Y/Y, but missed consensus estimates by 1 penny in a quarter that showed a mix of strong cigarette pricing to offset significant volume declines.  The company took up the lower end of its 2014 FY EPS guidance by 2 cents (now $2.54 to $2.59) and announced a new share repurchase program of $1B to be completed by the end of 2015.

All in, we expect MO to grind higher over the medium term, however we’re less constructive on the name than we’ve been on its peers in the year-to-date. Clearly the tobacco market is now focused squarely around RAI acquiring LO, and the implications around Imperial becoming the 3rd largest U.S. tobacco company. (Note: we removed out Best Ideas long position in LO on 7/15/14).

We expect MO to grind higher in the back half of the year should the company maintain and grow its Marlboro share, turn around the value perception of Skoal and maintain strong performance from Copenhagen smokeless. The company has an attractive dividend yield of 4.6% and an easier tax comp in the back half of the year (35%  vs 37% Y/Y). As we show below, it is trading above our intermediate term TREND line of support – a bullish signal in our model.

MO – Price Taking Negates Steep Volume Declines - zzz. mo

In the quarter MO continued to show strength in brand Marlboro (rose 0.3 points to 44%) which we expect to persist in 2H.  Cigarette revenue declined -1.2%, with volume down -5% (below the industry’s 2014 estimated volume decline of -4.5%), partially offset by pricing  of ~ +5.6%.

In Smokeless, strong performance came from Copenhagen (volume +7.8%) that offset weakness in Skoal (volume down -6.1% and share down -1.1 points in the quarter).  Combined (Copenhagen + Skoal) saw share jumped 0.4 share points to 51.1% in the quarter, the highest combined share since the acquisition of UST in 2009.

Like the rest of its Big Tobacco brethren, MO is rolling out its own e-cigarette under the MarkTen brand. The company reported MarkTen’s rolling launch started in June in 20 states in the western part of the U.S..  Now in 60,000 retail locations, the company plans to head eastward in the summer and into the fall.  Additionally, in the quarter it completed the acquisition of e-vapor business Green Smoke, which it plans to integrate alongside MarkTen.  Like LO’s blu and RAI’s VUSE, we expect marketing, advertising, and promotion costs (to win share and adoption) to eat into profitability over at least the next 2-4 quarters.  

The wine business showed strength, with revenue rising 6.6% in the quarter, and margin jumped 1 point to 19.9%, with volume increases from Chateau Ste. Michelle and 14 Hands offsetting declines in Columbia Crest.

Call with questions.

Howard Penney

Managing Director

Matt Hedrick

Associate

Fred Masotta

Analyst