ALTRIA GROUP, INC. annual report, FY2012

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Business context and reporting period

Altria Group, Inc.’s Form 10-K covers the fiscal year ended December 31, 2012; it is an annual filing, not a standalone fourth-quarter report. Altria’s businesses include U.S. cigarettes, cigars and smokeless tobacco, wine, and a run-off finance-lease portfolio. It also held a 26.9% interest in SABMiller, accounted for under the equity method. Segment presentation changed in 2012, with cigarettes and cigars combined as smokeable products; prior-period segment figures were recast.

Financial performance and condition

  • FY 2012 results: Net revenue was $24.618 billion, up 3.4% from $23.800 billion. Revenue includes excise taxes billed to customers. Operating income increased 19.5% to $7.253 billion; net earnings attributable to Altria rose 23.3% to $4.180 billion. Diluted EPS was $2.06, versus $1.64.
  • Margins and taxes: Gross profit was $9.563 billion (38.9% of net revenue); operating income was 29.5% of net revenue. The reported pretax margin was 26.3%, versus 23.5% in 2011. The effective tax rate declined to 35.4% from 39.2%.
  • Cash flow: Operating cash flow was $3.903 billion, up from $3.613 billion. Investing activities provided $920 million, primarily from finance-asset sales; capital expenditures were $124 million. Financing activities used $5.193 billion, including debt repurchases, dividends and share repurchases. Cash ended the year at $2.900 billion, down from $3.270 billion.
  • Debt and liquidity: Total debt was $13.878 billion, compared with $13.689 billion in 2011; the weighted-average coupon was 7.2%, down from 8.3%. Current assets of $6.315 billion were below current liabilities of $8.251 billion, and management reported a working-capital deficit. Altria had no short-term borrowings at year-end and had $3.0 billion available under its revolving credit facility. Debt-to-EBITDA and EBITDA-to-interest covenant ratios were 1.8x and 7.0x, respectively, against limits of 3.0x maximum and 4.0x minimum.
  • Segments: Smokeable products generated $22.216 billion revenue and $6.239 billion operating companies income; smokeless products, $1.691 billion and $931 million; wine, $561 million and $104 million; financial services, $150 million and $176 million. Smokeable income improved with pricing and cost management despite lower volume. Smokeless and wine income also increased. Financial services results rebounded from a 2011 loss driven principally by a leveraged-lease tax charge.
  • Shareholder returns: Dividends declared were $1.70 per share for 2012; the quarterly rate rose 7.3% to $0.44 in the third quarter. Dividends paid totaled $3.4 billion. Altria repurchased 34.9 million shares under its then-current program during 2012.

Fourth-quarter snapshot

For Q4 2012, net revenue was $6.242 billion, net earnings attributable to Altria were $1.103 billion, and diluted EPS was $0.55. The filing reports quarterly gross profit of $2.383 billion. Q4 2011 comparatives were $6.129 billion revenue, $836 million attributable earnings and $0.41 diluted EPS.

Material changes versus 2011

  • Revenue rose 3.4%; operating income rose 19.5%; attributable net earnings rose 23.3%; diluted EPS rose 25.6%.
  • Improved operating results reflected higher income across reportable segments, higher SABMiller equity earnings and lower net interest expense. 2011 had included a $627 million PMCC leveraged-lease charge, while 2012 included a $68 million net earnings benefit from the IRS closing agreement.
  • A 2012 debt tender offer generated an $874 million pretax loss on early extinguishment, including $864 million in premiums and fees. This partly offset the year’s operating improvement.
  • Operating cash flow increased, but year-end cash declined amid financing outflows. Total debt increased modestly despite repayment of $600 million of UST notes and the $2.0 billion tender offer, which was partly funded by new note issuance.
  • U.S. cigarette shipments declined 0.2%; smokeless shipments increased 3.9%; wine shipments increased 3.7%. Marlboro retail share improved to 42.6%, and Copenhagen and Skoal combined retail share increased to 50.6%.

Outlook, commentary, risks and unusual items

  • Management’s January 2013 forecast was reported diluted EPS of $2.34–$2.40 for 2013, including approximately $0.01 per share of specified net expenses. Adjusted diluted EPS growth was forecast at 6%–9% over 2012 adjusted EPS. The forecast excluded the potential impact of the pending non-participating-manufacturer (NPM) adjustment settlement.
  • Management expected $400 million of annualized savings from the 2011 Cost Reduction Program by the end of 2013; cumulative pretax charges were $271 million, and the program was substantially completed. Capital expenditures were forecast at $125–$150 million for 2013.
  • A term sheet with 17 states and other jurisdictions could provide PM USA an estimated $450 million credit against its April 2013 MSA payment, subject to arbitration-panel approval and potential challenges by non-signatory states. If effective, Altria expected to record a corresponding pretax earnings increase.
  • Management cited economic pressure on adult consumers and continued risk of state tobacco excise-tax increases. Other material risks include tobacco volume decline, down-trading and competition; FDA and other regulation; tobacco litigation; settlement and user-fee obligations; and disruption or supply risks. Tobacco-related payments under state settlements, FETRA and FDA fees were approximately $5.1 billion in 2012; management estimated approximately $5 billion annually on current assumptions, subject to variable adjustments.
  • Management stated that no loss was considered probable and reasonably estimable for pending tobacco cases, so no provision was recorded for such potential outcomes; it could not estimate a possible loss range. Litigation outcomes, appeals and bonding requirements could nevertheless materially affect results, cash flows or financial position in a particular period.
  • Other notable items: SABMiller equity earnings included non-cash gains from strategic alliance transactions; the company revised Q1 2012 results after identifying an omitted $342 million share of SABMiller gains. The 2012 annual review found no goodwill or indefinite-lived intangible impairment, although certain smokeless and cigar trademarks had limited fair-value cushions.

Important facts for investors to verify

  • Whether the NPM term sheet receives required approval, survives challenges, and results in the estimated $450 million credit and earnings recognition.
  • How much of 2013 EPS growth is expected from recurring operations versus pricing, cost savings, and other non-GAAP adjustments; review the reconciliation to reported EPS.
  • Whether tobacco shipment trends, premium-brand mix and retail share gains continue amid category decline, down-trading and excise-tax increases.
  • Developments in Engle progeny and other tobacco litigation, including judgments, appeals, settlement exposure and any changes to the company’s loss estimates.
  • Debt maturities, interest burden, working-capital deficit, pension funding and ability to sustain dividends and repurchases while maintaining credit metrics.
  • Results and valuation assumptions for the SABMiller investment and PMCC lease portfolio, including credit quality and asset-sale proceeds.