Altria Group, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; unaudited. Altria’s businesses include smokeable and smokeless tobacco, wine, innovative tobacco products and finance assets. It also held an approximately 10.2% equity-method interest in AB InBev.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net revenues | $6.663B | $6.521B | $12.746B | $12.587B |
| Gross profit | $3.119B | $2.957B | $5.898B | $5.613B |
| Operating income | $2.539B | $2.410B | $4.786B | $4.387B |
| Net earnings attributable to Altria | $1.989B | $1.653B | $3.390B | $2.870B |
| Diluted EPS | $1.03 | $0.84 | $1.75 | $1.47 |
| Dividends declared per share | $0.61 | $0.565 | $1.22 | $1.13 |
- Revenue increased 2.2% in Q2 and 1.3% for the first half. First-half operating income rose 9.1%; net earnings attributable to Altria increased 18.1% and diluted EPS rose 19.0%.
- Approximate gross and operating margins, calculated against reported net revenues: Q2 46.8% and 38.1%, respectively, versus 45.3% and 37.0%; first half 46.3% and 37.5% versus 44.6% and 34.8%.
- First-half operating cash flow was $1.948B, versus $1.088B. Investing used $246M and financing used $4.016B. Cash declined $2.314B to $2.255B.
- At June 30, total debt was $13.9B, essentially unchanged from year-end; no short-term borrowings were outstanding. The $3.0B revolving credit facility was fully available. Credit-agreement leverage and interest-coverage ratios were 1.3x and 14.7x, respectively. Current assets of $4.611B were below current liabilities of $5.582B.
- Altria repurchased $1.6B of shares and paid $2.369B in dividends in the first half. The July 2017 dividend rate was annualized at $2.44 per share; management cited an approximately 80% adjusted-EPS payout target.
Material changes and operating drivers
- Smokeable products: First-half revenue rose 1.1% to $11.380B and segment operating companies income rose 10.5% to $4.274B, mainly from pricing, partly offset by lower volume. Cigarette shipments fell 2.8%; Marlboro shipments fell 2.8% and retail share declined 0.3 percentage points. Management attributed pressure in Q2 in part to California’s cigarette excise-tax increase.
- Smokeless products: First-half revenue increased 2.8% to $1.030B, but segment income fell 3.1% to $599M. A voluntary product recall reduced first-quarter segment income by an estimated $60M; trade inventories were substantially replenished by the end of Q2. Q2 revenue and income increased 7.8% and 3.6%, respectively.
- Wine: First-half revenue fell 8.2% to $290M and segment income declined 25.8% to $46M. Shipments decreased 12.4%, reflecting trade inventory reductions and competitive activity.
- First-half results also benefited from lower impairment/exit costs and interest expense. Segment results were affected by settlement and litigation items, the smokeless recall, and the facilities consolidation.
Outlook, unusual items and risks
- Management reaffirmed expected 2017 adjusted diluted EPS growth of 7.5%–9.5% over 2016 adjusted diluted EPS, and an effective tax rate on operations of approximately 36%. It expected stronger adjusted-EPS growth in the second half, citing recall-related comparisons and four quarters of AB InBev equity income in 2017 versus three quarters of SABMiller equity income in 2016. These are non-GAAP outlook measures; the filing does not provide a corresponding GAAP forecast or reconciliation.
- Reported earnings included a $408M pre-tax gain related to AB InBev divestitures, versus a $157M gain in first-half 2016 related to a transaction-linked derivative. First-half 2017 also included $152M of tax benefits primarily from settlement of the IRS 2010–2013 audit, and $19M of excess share-based compensation tax benefits. These items materially affect reported-period comparisons.
- Facilities consolidation, expected to finish by Q1 2018, is estimated to cost about $150M pre-tax and generate approximately $50M of annualized savings by end-2018. A separate productivity initiative was expected to deliver about $300M of annualized savings by end-2017.
- Litigation remains a significant contingency. Management stated that it had not concluded a loss was probable or reasonably estimable for pending tobacco-related cases generally; thus, no general provision was recorded for possible unfavorable outcomes. The filing describes substantial pending Engle progeny and other claims, appeals, and possible damages, interest and attorneys’ fees.
- Other key risks include tobacco-volume and market-share declines, excise taxes, FDA regulation and product-authorization requirements, future product recalls, state settlement payments, and uncertainty in NPM-adjustment disputes. Estimated annual charges for state settlement agreements and FDA user fees were approximately $4.9B for 2017 and each year thereafter, before potential NPM adjustments; actual payments may vary.
- Altria’s investment in AB InBev is exposed to currency, business-performance and ownership-related risks; its restricted shares were subject to a five-year lock-up ending October 2021. Management said it believed liquidity and access to financing were adequate.
Most important facts for investors to verify
- How much reported earnings growth reflects underlying operations versus the $408M AB InBev-related gain and IRS audit tax benefits; review adjusted-EPS definitions and reconciliation limitations.
- Whether cigarette volume and Marlboro share stabilize after tax-driven declines, and whether pricing can offset continuing industry contraction.
- Whether smokeless shipments and share recover after the recall, and whether further recall-related costs arise.
- Developments in Engle progeny litigation, other tobacco cases, bond-cap challenges, and state NPM-adjustment and settlement disputes.
- Cash generation and funding capacity after dividends and buybacks, including the enlarged $4.0B repurchase authorization and the substantial recurring settlement and FDA-fee burden.