Altria Group, Inc. — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; unaudited. Altria’s businesses included U.S. cigarettes, smokeless tobacco, cigars, wine, finance leases, and a 27.2% interest in SABMiller. The comparison with Q1 2009 is affected by the April 2009 federal tobacco excise tax increase and the January 2009 UST acquisition.
Financial results and position
| Metric | Q1 2010 | Q1 2009 / prior date |
|---|---|---|
| Net revenues | $5.760 billion | $4.523 billion |
| Gross profit | $2.084 billion | $2.042 billion |
| Operating income | $1.430 billion | $1.191 billion |
| Net earnings | $813 million | $589 million |
| Diluted EPS | $0.39 | $0.28 |
| Cash from operations | $2.041 billion | $2.043 billion |
| Cash and equivalents | $3.290 billion | $1.871 billion at Dec. 31, 2009 |
| Total debt | $12.2 billion | $12.0 billion at Dec. 31, 2009 |
Revenue rose 27.3%, largely reflecting higher pricing associated with the federal excise tax increase; excise taxes recorded on products more than doubled to $1.809 billion. Consequently, revenue growth substantially exceeded gross-profit growth, and reported revenue-based margins are affected by the tax increase. Operating income increased 20.1%, while net earnings increased 38.0% and diluted EPS increased 39.3%. The effective tax rate was 36.5%, down from 38.7%.
At March 31, Altria had $200 million of short-term borrowings and $2.8 billion available under revolving credit facilities. Debt fair value was $14.7 billion versus a carrying value of $12.2 billion. The company reported covenant ratios of 1.9:1 debt to EBITDA and 5.7:1 EBITDA to interest expense, and expected to remain in compliance. Its quarterly dividend was increased 2.9% to $0.35 per share, or $1.40 annualized; the targeted payout ratio was raised to approximately 80% of adjusted diluted EPS.
Business performance and changes
- Cigarettes: Revenue was $5.123 billion and operating companies income was $1.230 billion, versus $3.896 billion and $1.143 billion, respectively. Domestic shipments declined 0.7% as reported; management estimated an approximately 11% decline after adjusting for trade inventories. Marlboro shipments increased 1.6%, while discount-brand shipments fell 17.0%. Pricing and lower restructuring costs partly offset volume declines and higher settlement charges, FDA fees, and material costs.
- Smokeless products: Revenue increased to $381 million from $298 million; operating companies income improved to $178 million from a $2 million loss. Reported shipments increased 21.9%, but management estimated underlying shipments rose about 5% after adjustments for product launches, inventory movements, and other comparability factors. Total retail share declined 0.8 percentage point year over year.
- Cigars: Revenue rose to $135 million from $115 million, while operating companies income declined to $47 million from $54 million. Shipments decreased 18.3%, which management attributed largely to inventory and prior-year product-launch timing; adjusted shipments were estimated to be essentially flat.
- Wine: Revenue increased to $95 million from $75 million and operating companies income to $7 million from $1 million. Shipments rose 22% as reported and an estimated 16% after adjusting for calendar differences.
- Financial services: Revenue fell to $26 million from $139 million and operating companies income to $21 million from $120 million, primarily because asset-sale gains were lower. PMCC recorded $64 million of lease-loss write-offs related to General Motors lease changes and rejection.
Outlook, commentary, and material risks
- Management reaffirmed 2010 reported diluted EPS guidance of $1.78–$1.82. Adjusted diluted EPS, a non-GAAP measure, was forecast to grow 6%–8% over 2009 adjusted EPS. The forecast included estimated net charges of $0.07 per share.
- Cost savings totaled $1.081 billion since 2007, including $43 million in Q1 2010. Management expected a further $419 million by the end of 2011, for anticipated total cost reductions of $1.5 billion versus 2006; it also expected approximately $300 million of UST integration savings by that date.
- Accrued settlement charges were $4.712 billion at March 31, up from $3.635 billion at year-end. State settlement, FETRA, and FDA user-fee charges were approximately $1.209 billion in the quarter. Estimated annual charges for these obligations were about $5.1 billion in 2010 and $5.2 billion in each of 2011–2014; actual amounts depend on volume, market share, inflation, and other factors.
- Litigation remains a significant contingent risk. Management said it had not recorded provisions for pending tobacco-related cases where loss was not considered probable and reasonably estimable, while warning that an adverse outcome could materially affect a period’s results, cash flows, or financial position. The filing describes numerous pending cases and verdicts, including Engle progeny litigation. An April 23, 2010 Louisiana appellate decision reduced the Scott smoking-cessation judgment to approximately $241 million plus interest; the company intended to seek rehearing.
- PMCC faced IRS challenges to leveraged-lease tax treatment. The filing discusses approximately $1.0 billion of potential federal tax and interest disallowances for 2000–2003 and a further approximately $1.0 billion scenario for 2004–2010, excluding potential penalties; amounts depend on audits, challenges, and litigation. Altria intended to appeal an adverse judgment concerning earlier tax years.
- Other key exposures include declining cigarette consumption, further excise taxes, FDA regulation and compliance costs, competition and down-trading, tobacco litigation and settlement payments, and economic and credit risks in PMCC’s lease portfolio. Management stated it believed liquidity was adequate for foreseeable needs. The share-repurchase program remained suspended indefinitely.
Important facts for investors to verify
- Underlying cigarette and smokeless shipment trends after adjusting for tax-related trade inventory movements, and whether pricing can offset continuing industry volume declines.
- The composition and cash-payment timing of the $4.712 billion settlement accrual and the assumptions behind forecast settlement, FETRA, and FDA charges.
- Developments and potential exposure in Engle progeny and other tobacco cases, including the Scott judgment and pending appeals.
- Progress and outcomes in the PMCC leveraged-lease tax disputes, including the potential tax, interest, and penalty implications.
- Delivery of the 2010 EPS guidance and expected cost savings, alongside the company’s leverage, available credit, dividend policy, and suspended repurchase program.