Business Context and Reporting Period
Company: Altria Group, Inc. (ALG)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Nine months and three months ended September 30, 2006
Business Overview: ALG operates through its subsidiaries Philip Morris USA (PM USA), Philip Morris International (PMI), and Kraft Foods Inc. (Kraft, 88.6% owned). The company manufactures and sells tobacco products, packaged food, snacks, and beverages. It also holds a financial services subsidiary, Philip Morris Capital Corporation (PMCC).
Strategic Note: On October 25, 2006, the Board announced it intends to finalize a decision on distributing all Kraft shares to ALG shareholders by January 31, 2007.
Key Financial Metrics
| Metric (in millions) | Nine Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2005 | Three Months Ended Sep 30, 2006 | Three Months Ended Sep 30, 2005 |
|---|---|---|---|---|
| Net Revenues | $76,009 | $73,364 | $25,885 | $24,962 |
| Operating Income | $13,195 | $12,962 | $4,713 | $4,315 |
| Net Earnings | $9,063 | $8,146 | $2,875 | $2,883 |
| Diluted EPS (Continuing Ops) | $4.31 | $4.01 | $1.36 | $1.38 |
| Net Cash from Operating Activities | $11,144 | $7,955 | N/A | N/A |
| Total Debt (Consumer Products) | $18,539 | $21,929 | N/A | N/A |
| Cash and Cash Equivalents | $5,695 | $6,258 | N/A | N/A |
Note: Debt figures represent total consumer products debt (short-term + long-term). Total consolidated debt was $19.6 billion at Sep 30, 2006.
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased 3.6% for the nine months ended Sep 30, 2006, driven by higher pricing and acquisitions (Sampoerna in Indonesia, Coltabaco in Colombia), partially offset by unfavorable currency impacts and divestitures.
- Earnings Increase: Net earnings rose 11.3% year-over-year for the nine-month period. This was significantly boosted by a non-cash tax benefit of approximately $1.0 billion resulting from the reversal of tax reserves following an IRS examination conclusion.
- Asset Impairment and Exit Costs: Pre-tax charges totaled $676 million for the nine months of 2006, compared to $302 million in 2005. This increase was primarily due to Kraft's expanded restructuring program ($496 million) and asset impairments related to divestitures.
- United Biscuits Gain: Kraft recorded a $251 million pre-tax gain in Q3 2006 from the redemption of its investment in United Biscuits, which also involved the acquisition of UB's Spanish and Portuguese operations.
- Debt Reduction: Total consumer products debt decreased by approximately $3.4 billion compared to the prior year-end, reflecting debt repayments and lower short-term borrowings.
Guidance, Outlook, and Risks
Guidance and Outlook
- 2006 Full-Year Forecast: ALG projects 2006 full-year diluted EPS from continuing operations in the range of $5.48 to $5.53, an increase from the previous range of $5.40 to $5.50. This revision includes the gain from the sale of Kraft's rice brand (approx. $0.07/share) and the United Biscuits redemption gain (approx. $0.06/share).
- Dividends: The quarterly dividend was increased by 7.5% to $0.86 per share in Q3 2006, resulting in an annualized rate of $3.44 per share.
- Kraft Restructuring: Kraft expects full-year 2006 charges related to restructuring and impairments to total approximately $1 billion. Cumulative savings are expected to reach $530 million by year-end.
Risks and Contingencies
- Tobacco Litigation: Significant pending litigation includes the U.S. government's RICO lawsuit (judgment entered in August 2006, stayed pending appeal), the Engle class action in Florida (class decertified, punitive damages vacated, but Phase I findings stand for individual suits), and the Price case in Illinois (dismissed by state supreme court, pending U.S. Supreme Court review).
- IRS Challenges: The IRS disallowed tax benefits for certain PMCC leveraged lease transactions for 1996-1999. PMCC contests approximately $150 million in assessed tax and interest. An unfavorable outcome could materially affect earnings and cash flows.
- Airline Exposure: PMCC holds leveraged leases with Delta and Northwest Airlines, both in bankruptcy. PMCC increased its allowance for losses by $103 million in Q2 2006 due to continuing industry issues.
- Regulatory Environment: Ongoing risks include excise tax increases, restrictions on marketing (e.g., "Lights" descriptors), and potential FDA regulation of tobacco products.
Investor Verification Checklist
- Tax Benefit Sustainability: Verify the permanence of the $1.0 billion non-cash tax benefit and the status of the ongoing dispute regarding PMCC leveraged leases.
- Kraft Spin-off Timeline: Monitor the January 31, 2007 Board meeting for the final decision on the distribution of Kraft shares and potential legal challenges to the spin-off.
- Restructuring Execution: Track Kraft's ability to meet its $1 billion charge target and $530 million savings target for 2006 amidst ongoing divestitures.
- Litigation Outcomes: Watch for rulings on the U.S. government's RICO appeal and the U.S. Supreme Court's decision on the Price case, which could impact future bonding requirements and liabilities.
- Debt Covenants: Confirm continued compliance with debt covenants, particularly PMI's EBITDA to interest ratio (currently 30.0 to 1.0) and ALG's earnings to fixed charges ratio (currently 10.8 to 1.0).