Altria Group, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; unaudited. Altria’s businesses include U.S. cigarettes, cigars, smokeless tobacco, wine, innovative tobacco products and finance assets. It also held approximately 27% of SABMiller and accounted for that investment under the equity method.
Financial results
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net revenues | $5.804 billion | $5.517 billion | +5.2% |
| Gross profit | $2.475 billion | $2.256 billion | +9.7% |
| Operating income | $1.865 billion | $1.734 billion | +7.6% |
| Net earnings attributable to Altria | $1.018 billion | $1.175 billion | -13.4% |
| Basic and diluted EPS | $0.52 | $0.59 | -11.9% |
| Operating cash flow | $2.498 billion | $2.125 billion | +$373 million |
- Gross margin, calculated on reported net revenues, was approximately 42.6%, versus 40.9% a year earlier. Operating margin was approximately 32.1%, versus 31.4%. Net revenues include excise taxes billed to customers.
- Investing activities provided $99 million; financing activities used $2.244 billion. Capital expenditures were $48 million. Cash increased $353 million to $3.674 billion.
- At March 31, total debt was approximately $13.9 billion, including $1.0 billion current and $12.9 billion long-term, versus $14.7 billion at year-end. Altria repurchased $793 million principal of 9.700% notes due 2018 and recorded a $228 million pretax extinguishment loss, including $226 million of premiums and fees.
- Current assets were $7.233 billion and current liabilities $8.895 billion, a $1.662 billion working capital deficit. Management said it expected to fund the deficit through operating cash flow and/or commercial paper. The $3.0 billion revolving credit facility was undrawn; covenant ratios were 1.7x debt/EBITDA and 10.0x EBITDA/interest expense.
- Dividends declared were $0.52 per share, versus $0.48. Dividends paid totaled $1.026 billion. The annualized dividend rate was $2.08 per share; the stated payout-ratio target was approximately 80% of adjusted diluted EPS.
Business performance and comparison with prior year
- Smokeable products: Revenue rose 5.3% to $5.221 billion and operating companies income increased 10.1% to $1.686 billion, principally on pricing, volume and lower resolution expenses. Cigarette shipments rose 1.6%; Marlboro retail share increased 0.3 percentage points to 44.0%, and total cigarette share rose 0.4 points to 51.1%. Management estimated adjusted domestic cigarette shipments were essentially unchanged and industry volume declined about 0.5% for the quarter. Premium cigarettes’ share of Altria shipments declined to 91.4% from 92.0%.
- Smokeless products: Revenue grew 3.6% to $430 million and operating companies income rose 5.0% to $251 million, primarily due to pricing. Shipments increased 2.7%; Copenhagen and Skoal combined shipments rose 3.7% and combined retail share gained 0.5 points to 51.2%.
- Wine: Revenue increased 3.9% to $134 million and operating companies income rose 22.7% to $27 million, mainly from improved premium mix. Shipments increased 0.5%.
- Consolidated operating income rose despite higher marketing, administration and research costs, which increased 17.3% to $610 million. SABMiller equity earnings fell to $134 million from $225 million, affected by special items and unfavorable currency movements. The 2015 period also included the debt extinguishment loss and a $43 million tobacco-litigation provision; 2014 included $64 million of NPM-related interest income.
- Operating cash flow increased, which management attributed primarily to higher smokeable-products revenue and working-capital timing. Cash flow also reflected a $1.051 billion increase in accrued settlement charges and $541 million of cash effects from income taxes; these timing and accrual items are relevant to assessing cash-flow sustainability.
Outlook, commentary and risks
- In April 2015, Altria reaffirmed full-year 2015 adjusted diluted EPS growth guidance of 7% to 9% over 2014 adjusted diluted EPS. The forecast excludes specified special items and is not reconciled to a GAAP forecast because management cannot estimate those items’ future impact.
- Management cited higher smokeable-products income as the main source of the quarter’s underlying operating improvement, partly offset by increased investment in innovative tobacco products. The July 2014 $1.0 billion share-repurchase program had approximately $326 million remaining; the company expected to complete it by year-end 2015, subject to market conditions and Board discretion.
- State settlement agreements, FETRA and FDA user fees produced approximately $1.1 billion of cost-of-sales charges in each quarter. Altria estimated related 2015 and subsequent annual charges at approximately $4.6 billion, excluding potential effects of revised NPM adjustment provisions. FETRA obligations expired after Q3 2014.
- PM USA and other manufacturers reached a tentative agreement to resolve approximately 415 federal Engle progeny cases. PM USA deposited approximately $43 million into escrow and recorded the same amount as a provision; the agreement was subject to approval by the affected plaintiffs or other agreement among the parties.
- Litigation remains a substantial contingency. Management said it could not conclude that losses in pending tobacco-related cases were probable or reasonably estimate a possible loss range, except for specifically recorded matters. Unfavorable outcomes could materially affect results, cash flow or financial position. The filing discusses extensive Engle progeny litigation, other tobacco cases and a pending appeal involving the Price case; claimed damages in some proceedings are very large.
- Other significant risks include FDA regulation and proposed rules covering e-vapor and other products, possible restrictions on menthol, tobacco excise-tax increases, declining cigarette consumption, down-trading and illicit trade, competition, agricultural supply and price changes, currency effects on SABMiller, and wine-market competition. Altria disclosed that an April 2015 lawsuit challenged new FDA substantial-equivalence reporting requirements.
Most important facts for investors to verify
- Whether the federal Engle agreement receives the required approvals and whether additional state and individual tobacco litigation creates material liabilities or cash requirements.
- The status and potential financial consequences of major litigation, including the Price case appeal and the Florida Engle-related legal decisions; management’s loss estimates remain limited.
- Whether reported operating cash flow is repeatable after considering settlement accruals, tax timing and other working-capital movements.
- Progress toward 2015 adjusted EPS growth guidance, including the size and timing of excluded special items and the gap between adjusted and GAAP results.
- Trends in underlying cigarette and smokeless category volumes, market share, pricing and consumer shifts to discount, illicit or alternative products.
- Debt, liquidity and capital returns, including the debt tender’s full effect, working-capital deficit, remaining repurchase authorization and dividend sustainability.
- Developments in FDA rules, state and federal tobacco taxes, settlement-related payments and disputed NPM adjustment recoveries.