ALTRIA GROUP, INC. quarterly report, Q1 FY2017

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Altria Group, Inc. — Q1 2017 Form 10-Q

Business context and period. Unaudited results cover the three months ended March 31, 2017, compared with Q1 2016. Altria’s businesses include U.S. smokeable and smokeless tobacco, wine, innovative tobacco products and financial services. It also held an approximately 10.2% equity-method investment in AB InBev.

Financial results and liquidity

  • Revenue: Net revenues were $6.083 billion, up 0.3% from $6.066 billion. Reported revenue includes excise taxes billed to customers.
  • Profit: Gross profit was $2.779 billion, operating income $2.247 billion and net earnings attributable to Altria $1.401 billion, up 15.1%. Basic and diluted EPS were $0.72, up 16.1% from $0.62.
  • Margins: Gross margin was approximately 45.7%, operating margin 36.9% and net margin attributable to Altria 23.0%, calculated using reported net revenues.
  • Cash flow: Operating cash flow was $2.665 billion versus $2.718 billion. Capital expenditures were $33 million; investing activities used $230 million. Financing activities used $1.776 billion, including $1.187 billion of dividends and $551 million of share repurchases. Cash increased $659 million to $5.228 billion.
  • Debt and liquidity: Long-term debt was $13.884 billion, with no short-term borrowings. The company had $3.0 billion available under its revolving credit agreement. Current assets of $7.626 billion were below current liabilities of $8.300 billion, a $674 million working-capital deficit; management said operating cash flow and/or short-term borrowing capacity could fund working-capital needs. Credit-agreement leverage and interest-coverage ratios were 1.4x and 13.8x, respectively, within required limits.
  • Capital returns: The declared quarterly dividend was $0.61 per share; the annualized rate was $2.44. Management targeted a dividend payout ratio of approximately 80% of adjusted diluted EPS. About $1.384 billion remained under the share-repurchase authorization at quarter-end.

Material changes versus Q1 2016

  • Operating income rose 13.7% to $2.247 billion, driven mainly by higher smokeable-products results and lower prior-year impairment, restructuring and litigation costs.
  • Smokeable-products revenue increased to $5.458 billion and segment operating companies income rose 16.6% to $2.041 billion, primarily on pricing. Cigarette shipment volume fell 2.7%; Marlboro retail share declined 0.2 percentage points to 43.6%.
  • Smokeless-products revenue declined 2.7% to $466 million and segment operating companies income fell 11.1% to $249 million. A voluntary recall reduced segment operating companies income by an estimated $60 million; volume fell 5.0% and share declined 0.7 percentage points.
  • Wine revenue decreased 3.4% to $140 million and segment operating companies income decreased 25.0% to $21 million, reflecting lower shipment volume and higher costs.
  • Interest and other debt expense declined 10.5% to $179 million. Equity earnings from AB InBev/SABMiller fell to $23 million from $66 million; the 2016 comparison included a $40 million business-combination-related gain.
  • The reported effective tax rate was 33.0%, down 2.3 percentage points, partly due to $42 million of prior-audit-year tax benefits and $16 million of excess share-award tax benefits.

Outlook, commentary and risks

  • Management reaffirmed expected 2017 adjusted diluted EPS growth of 7.5%–9.5% over 2016 adjusted diluted EPS, excluding specified special items. It expected stronger adjusted EPS growth in the second half, citing the recall’s year-over-year comparison and four quarters of AB InBev equity income in 2017 versus three in 2016. The forecast effective tax rate on operations was approximately 36%. These are non-GAAP outlook measures; management did not provide a corresponding GAAP reconciliation because excluded items may be difficult to predict.
  • The smokeless-products recall followed a product-tampering incident at the Franklin Park facility. USSTC said it had concluded the recall and was replenishing trade inventories.
  • Facilities consolidation was expected to finish by Q1 2018, with approximately $150 million of total pre-tax charges and about $50 million of annualized savings by the end of 2018. The separate productivity initiative was expected to deliver approximately $300 million of annualized savings by the end of 2017.
  • Litigation remains a material uncertainty. Management stated it had not concluded that losses were probable and estimable for pending tobacco cases generally, and therefore had not provided for potential unfavorable outcomes beyond disclosed provisions. The filing describes substantial tobacco, Engle progeny and other litigation exposure, including possible large judgments, appeals and bonding risks.
  • Other risks include FDA regulation and product-authorization requirements, possible tobacco product standards, excise-tax increases, declining cigarette industry volume, competition and down-trading, illicit trade, product recalls, and changes in agricultural input availability or cost. The proposed FDA standard for NNN in smokeless tobacco could be material if finalized and upheld.
  • The $17.579 billion carrying value of the AB InBev investment is exposed to currency movements, AB InBev performance and transaction-integration risks; a substantial portion of the shares received in the SABMiller transaction is restricted until 2021.
  • Unusual items affecting comparability included the $60 million recall impact, 2017 AB InBev-related mark-to-market charges, NPM settlement adjustments, and substantially higher 2016 impairment and litigation costs. State settlement agreement and FDA user-fee charges were approximately $1.2 billion in each quarter; management estimated roughly $4.9 billion annually based on current assumptions, excluding potential NPM adjustments.

Most important facts for investors to verify

  • Whether recall-related inventory replenishment and smokeless-product volumes and market share recover, and whether additional recall effects arise.
  • Progress toward the 7.5%–9.5% adjusted EPS growth outlook, including the assumptions for second-half performance, taxes and AB InBev contributions.
  • Developments in tobacco litigation, accrued settlement liabilities, appeal bonds and the uncertain timing and amounts of NPM Adjustment recoveries or payments.
  • Whether projected cost savings from the facilities consolidation and productivity initiative are achieved without disrupting operations.
  • Exposure from tobacco regulation, excise taxes and declining cigarette volumes, alongside the carrying value and restrictions on Altria’s AB InBev investment.