Altria Group, Inc. — Q1 2018 Form 10-Q
Business context and reporting period. This unaudited filing covers the three months ended March 31, 2018, compared with Q1 2017. Altria’s businesses include U.S. smokeable and smokeless tobacco, wine, and other operations; it also holds an approximately 10.2% equity-method investment in AB InBev.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenues | $6.108 billion | $6.083 billion | +0.4% |
| Gross profit | $2.936 billion | $2.776 billion | +5.8% |
| Operating income | $2.316 billion | $2.239 billion | +3.4% |
| Net earnings attributable to Altria | $1.894 billion | $1.401 billion | +35.2% |
| Diluted EPS | $1.00 | $0.72 | +38.9% |
| Operating cash flow | $2.809 billion | $2.675 billion | +5.0% |
| Cash and cash equivalents at period end | $2.191 billion | Compared with $1.253 billion at Dec. 31, 2017 | |
| Total debt at period end | $13.897 billion | Essentially unchanged from Dec. 31, 2017 |
Gross profit was 48.1% of reported net revenues versus 45.6% a year earlier; operating income was 37.9% versus 36.8%. Net revenues include excise taxes billed to customers, so these ratios should be interpreted with that presentation in mind. The effective income tax rate declined to 23.2% from 33.0%, primarily reflecting the Tax Cuts and Jobs Act.
Operating cash flow exceeded cash used in investing ($41 million) and financing activities ($1.793 billion). Financing outflows included $1.257 billion of dividends paid and $513 million of share repurchases. Current assets were $4.824 billion and current liabilities $7.475 billion, a working capital deficit of $2.651 billion. Management said it expects operating cash flow and/or commercial paper borrowings to fund working capital needs. The $3.0 billion revolving credit facility was undrawn; covenant ratios were within limits.
Changes and segment results
- Smokeable products: Revenue fell 0.8% to $5.414 billion; operating companies income was nearly flat at $2.038 billion. Cigarette shipments declined 4.2%, and total cigarette retail share fell 0.7 percentage point to 50.3%; Marlboro share declined 0.5 point to 43.2%.
- Smokeless products: Revenue rose 12.7% to $525 million and operating companies income rose 37.4% to $338 million. The comparison benefited from the approximately $60 million impact of the 2017 product recall; shipments were essentially unchanged.
- Wine: Revenue increased 1.4% to $142 million, while operating companies income declined 19.0% to $17 million, reflecting higher costs and unfavorable premium mix.
- AB InBev investment: Equity earnings increased to $342 million from $23 million. Q1 2018 included $117 million of net pre-tax AB InBev special-item income, primarily Altria’s share of estimated Tax Reform Act effects, partly offset by derivative mark-to-market losses. Q1 2017 included $73 million of net pre-tax special-item charges.
Consolidated earnings also benefited from lower taxes, higher AB InBev equity earnings and improved smokeless results. Reported earnings included $68 million of favorable NPM adjustment items, $28 million of tobacco-litigation charges and a $33 million loss on the AB InBev/SABMiller business combination. The filing’s reconciliation attributes much of the EPS increase to the lower tax rate and special items, as well as operations and fewer shares outstanding.
Outlook, risks and unusual items
- Management reaffirmed expected 2018 adjusted diluted EPS growth of 15%–19% over 2017 adjusted diluted EPS and an adjusted effective tax rate of approximately 23%–24%. Guidance excludes certain potentially significant, variable items; the filing does not provide a corresponding GAAP EPS forecast or reconciliation.
- Management expects to reinvest approximately one-third of the Tax Reform Act liquidity benefit in 2018, with a moderating level of investment in subsequent years. It also expects approximately $50 million of annualized savings from completed manufacturing consolidations by year-end 2018.
- The quarterly dividend increased 6.1% to $0.70 per share, or $2.80 annualized. The company targets a dividend payout ratio of approximately 80% of adjusted diluted EPS, subject to Board discretion. A new $1.0 billion repurchase program had approximately $505 million remaining at March 31; management expected completion by year-end.
- Long-term debt carrying value was $13.9 billion; fair value was $14.7 billion. Credit ratings were A3 (Moody’s) and A- (S&P and Fitch), all with stable outlooks. The $3.0 billion credit facility expires in August 2020.
- Litigation remains a significant uncertainty, particularly tobacco and Engle progeny cases. Management stated that losses in pending tobacco-related cases were not considered probable, and it could not estimate possible losses or ranges for those cases; adverse outcomes could nevertheless materially affect results, cash flows or financial position. Accrued tobacco and health litigation liability was $111 million at quarter-end.
- State settlement agreements and FDA user fees generated approximately $1.1 billion of Q1 cost-of-sales charges. The company estimated these charges at approximately $4.8 billion for 2018 and each year thereafter, excluding potential NPM adjustment effects; actual amounts depend on volume, market share, inflation and other factors.
- Key industry risks include declining cigarette consumption, excise-tax increases, competition and down-trading, FDA product review and potential standards for nicotine or flavors, product recalls, illicit trade, raw-material supply, and litigation. The FDA’s March 2018 notices on nicotine and flavors are requests for comment, not final product rules.
Investor verification points
- Confirm the composition and sustainability of the earnings increase, especially the lower tax rate and AB InBev special items, against adjusted results and subsequent periods.
- Track cigarette shipment and retail-share trends, pricing and promotional spending, and whether smokeless growth persists after the prior-year recall comparison.
- Review operating cash generation, the working capital deficit, debt maturities and compliance with revolving-credit covenants.
- Monitor tobacco litigation outcomes, bonding requirements, settlement liabilities and NPM adjustment disputes, including the uncertainty around unaccrued losses.
- Assess execution of the 2018 adjusted EPS outlook, tax-rate forecast, planned investments, cost savings, dividend and repurchase program; the outlook excludes items that may be significant.