Altria Group, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2018, compared with the same 2017 periods. Altria’s businesses include U.S. smokeable and smokeless tobacco, wine, innovative tobacco products and finance assets. It also held approximately 10.1% of AB InBev, accounted for under the equity method.
Key financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net revenues | $6.305B | $6.663B | $12.413B | $12.746B |
| Gross profit | $3.141B | $3.114B | $6.077B | $5.890B |
| Operating income | $2.498B | $2.528B | $4.814B | $4.767B |
| Net earnings attributable to Altria | $1.876B | $1.989B | $3.770B | $3.390B |
| Diluted EPS | $0.99 | $1.03 | $1.99 | $1.75 |
| Dividends declared per share | $0.70 | $0.61 | $1.40 | $1.22 |
Net revenues include excise taxes billed to customers. Calculated from reported figures, gross margin was approximately 49.8% in Q2 and 49.0% in the first half; operating margin was approximately 39.6% and 38.8%, respectively.
- Cash flow: First-half operating cash flow was $3.850B, versus $1.945B; investing cash outflow was $81M and financing cash outflow was $3.560B. Capital expenditures were $72M. Operating cash flow’s increase mainly reflected lower settlement-charge and income-tax payments.
- Liquidity and debt: June 30 cash and cash equivalents were $1.430B, plus $93M restricted cash. Total debt was $13.9B, including $864M current and $13.036B long-term; no short-term borrowings were outstanding. Current assets of $4.131B were below current liabilities of $6.388B. The company reported a $3.0B undrawn revolving credit facility and said it had adequate liquidity. Credit-agreement leverage and interest-coverage ratios were 1.3x and 14.8x, respectively, against limits of 3.0x maximum and 4.0x minimum.
- Dividends and repurchases: The quarterly dividend was increased 6.1% to $0.70 per share, or $2.80 annualized; management’s target payout ratio is approximately 80% of adjusted diluted EPS. First-half repurchases totaled $950M. A $2.0B repurchase program had approximately $1.068B remaining at quarter-end.
Changes versus the prior comparable period
- Q2 revenue fell 5.4%, operating income fell 1.2%, net earnings attributable to Altria fell 5.7% and diluted EPS fell 3.9%. Lower smokeable-product volume and higher investment spending were key pressures; improved smokeless results and AB InBev earnings partly offset them.
- For the first half, revenue declined 2.6%, while operating income rose 1.0%, net earnings attributable to Altria rose 11.2% and diluted EPS rose 13.7%. Lower taxes, higher AB InBev equity earnings and fewer shares outstanding supported earnings. The year-over-year comparison also reflects a $408M AB InBev/SABMiller-related gain in 2017.
- Smokeable-product revenue and segment operating income declined. Cigarette shipments fell 7.6% in the first half and 10.8% in Q2; management estimated declines of 5.5% and 5.0%, respectively, after adjusting first-half and quarterly comparisons for trade inventory movements. Total cigarette retail share fell 0.8 and 0.7 percentage points, respectively.
- Smokeless-product first-half revenue rose 7.2% and segment operating income rose 20.6%, benefiting from pricing, lower facility-consolidation costs and comparison with a 2017 product recall. Total smokeless shipments fell 1.3% in the first half; retail share was flat at 54.0%.
- Wine first-half revenue rose 6.2%, while segment operating income declined 4.3%; Q2 revenue and operating income increased 10.7% and 8.0%, respectively.
Outlook, commentary, risks and unusual items
- Guidance: In July 2018, Altria raised the lower end of its 2018 adjusted diluted EPS growth outlook to 16%–19% over 2017 adjusted EPS, and forecast an adjusted effective tax rate of approximately 23%–24%. These are non-GAAP measures; management said it could not provide a corresponding GAAP reconciliation because excluded items may be significant and difficult to predict.
- Investment and efficiencies: Management expects to reinvest approximately one-third of the Tax Reform Act benefit in 2018, with a moderating level of investment thereafter. Facility consolidation was completed in Q1 2018 and is expected to deliver approximately $50M of annualized savings by year-end 2018.
- Tax and equity-investment items: The reported first-half tax rate fell to 24.9% from 32.2%, primarily reflecting the federal corporate tax-rate reduction to 21%; 2017 also included tax benefits from settlement of an IRS audit. Altria recorded $570M of first-half AB InBev equity earnings versus $163M in 2017, including $189M of net pre-tax special-item income. The filing also reports a $33M loss on AB InBev/SABMiller-related divestitures in 2018 versus a $408M gain in 2017.
- Settlement and litigation exposure: State settlement agreements and FDA user fees generated $2.1B of first-half cost-of-sales charges. Management estimated these charges at approximately $4.6B for 2018 and $4.8B annually thereafter, excluding potential NPM adjustments. PM USA recorded $145M of first-half NPM adjustment benefits. The filing describes substantial tobacco litigation, including approximately 2,300 pending state Engle progeny cases; management said losses in pending tobacco cases were not considered probable and could not be reasonably estimated, except for amounts specifically discussed. An unfavorable outcome, appeal-bond developments or further litigation could materially affect results or cash flows.
- Regulatory and market risks: Risks include FDA review and potential standards for nicotine, flavors and smokeless products; excise-tax increases; declining cigarette consumption and competitive pressure; illicit trade; product recalls; supply and manufacturing disruptions; and evolving consumer preferences. Altria also cited risks related to AB InBev performance, currency, and the restricted AB InBev shares it holds.
Most important facts for investors to verify
- Whether the 16%–19% adjusted EPS growth outlook and 23%–24% adjusted tax-rate forecast remain achievable, and how excluded items affect GAAP results.
- Whether cigarette shipment and retail-share declines stabilize, and whether pricing can continue to offset volume and cost pressures.
- Actual settlement payments, NPM adjustment recoveries and developments in tobacco litigation, including Engle progeny appeals and related accruals.
- Cash-flow sustainability after the unusually low 2018 settlement and tax payments, alongside dividend and share-repurchase commitments.
- AB InBev’s contribution to earnings and cash dividends, and the implications of its valuation, currency exposure and share-transfer restrictions.