ALTRIA GROUP, INC. quarterly report, Q2 FY2015

Altria Group, Inc. — Q2 2015 Form 10-Q

Reporting period: Three and six months ended June 30, 2015; financial statements are unaudited. Altria’s businesses include U.S. smokeable and smokeless tobacco, wine, financial services and innovative tobacco products. It also held approximately 27% of SABMiller, accounted for under the equity method. Dollar amounts below are in millions unless stated otherwise.

Financial performance

Metric	Six months 2015	Six months 2014	Q2 2015	Q2 2014
Net revenues	$12,417	$11,773	$6,613	$6,256
Gross profit	$5,346	$4,859	$2,871	$2,603
Operating income	$4,089	$3,709	$2,224	$1,975
Net earnings attributable to Altria	$2,466	$2,437	$1,448	$1,262
Basic and diluted EPS	$1.25	$1.23	$0.74	$0.64

For the first half, revenue rose 5.5%, operating income 10.2%, net earnings 1.2% and EPS 1.6%. In Q2, revenue increased 5.7%, operating income 12.6%, net earnings 14.7% and EPS 15.6% year over year.
Calculated from reported figures, gross margin was approximately 43.1% for the first half (41.3% in 2014) and 43.4% for Q2 (41.6%); operating margin was approximately 32.9% (31.5%) and 33.6% (31.6%), respectively.
First-half operating cash flow was $1,247, up from $759. Investing activities provided $87; financing activities used $3,532. Cash declined to $1,123 from $3,321 at year-end, reflecting dividends, debt repayment, repurchases and other financing outflows.
Cash dividends paid were $2,050; common-stock repurchases used $455. Dividends declared were $1.04 per share in the first half versus $0.96 a year earlier.
Total debt was $13.9 billion at June 30, down from $14.7 billion at December 31, 2014. Current and long-term debt were $1,003 and $12,917. Altria repurchased $793 of 9.700% notes due 2018 and recognized a $228 pretax early-extinguishment loss.
Current assets of $4,633 were below current liabilities of $6,261, a working-capital deficit of $1,628. Management said it expected to fund working-capital needs from operating cash flow and/or short-term borrowings. The $3.0 billion revolver was undrawn; covenant ratios were 1.6x debt/EBITDA and 10.5x EBITDA/interest, against limits of 3.0x maximum and 4.0x minimum.

Material changes and business drivers

Smokeable products drove most growth: first-half segment revenue increased to $11,195 from $10,569 and operating companies income to $3,710 from $3,320. Reported cigarette shipments rose 2.4%; Marlboro retail share increased 0.3 percentage points to 44.1%, while total cigarette share rose 0.5 points to 51.3%. Management cautioned that favorable trade-inventory movements were expected to moderate.
Smokeless revenue rose to $911 from $879 and operating companies income to $544 from $524. First-half shipment volume grew 2.6%; total retail share was flat at 54.8%. Copenhagen gained share while Skoal lost share.
Wine revenue increased to $295 from $275 and operating companies income to $62 from $50, supported by higher shipments and improved premium mix.
SABMiller equity earnings fell to $359 from $425 for the first half, affected by special items and unfavorable currency translation. Altria recorded its share of $88 in SABMiller pretax special charges.
Operating cash flow improved partly because federal tobacco quota buy-out payments ended after Q3 2014. First-half settlement payments remained substantial: cash paid against accrued settlement charges was $1,294.

Outlook, commentary and significant risks

In July 2015, Altria raised its 2015 forecast for adjusted diluted EPS growth to 7.5%–9.5% over 2014 adjusted diluted EPS. Management expected growth to moderate in the second half, citing comparison with prior-year economic and gasoline-price benefits, anticipated trade-inventory movements and state excise-tax increases. The forecast excludes specified items and is non-GAAP; the filing provides no corresponding GAAP reconciliation.
Management’s dividend payout-ratio target was approximately 80% of adjusted diluted EPS; the annualized dividend rate was $2.08 per share. Future dividends remain subject to board discretion. In July, the board authorized a new $1.0 billion repurchase program, expected to be completed by the end of 2016.
The filing describes significant tobacco litigation exposure. Management generally concluded that losses in pending tobacco cases were not probable and could not be reasonably estimated, so no amounts were accrued for those cases except as specifically disclosed. The accrued settlement-charge liability was $2,206 at June 30. A tentative agreement to resolve approximately 415 federal Engle progeny cases involved a $43 payment into escrow and remained subject to plaintiff approval or other agreement. PM USA had posted approximately $64 in security for appealed judgments.
Other material risks include adverse litigation outcomes and bonding challenges; FDA and other regulatory actions; tobacco excise taxes and settlement payments; declining cigarette consumption, down-trading and competition from discount, illicit and alternative products; and currency, credit, agricultural-supply, operational and cyber risks. The filing also identifies unresolved NPM Adjustment disputes, with potential recoveries dependent on proceedings and state determinations.
Altria recorded a $35 reduction in PMCC aircraft residual values in Q2, reducing revenue by $29. PMCC reported $1,339 of net finance assets; all lessees were current on lease payments at June 30.

Most important facts for investors to verify

Whether the adjusted EPS growth forecast is achieved, and how excluded items affect GAAP EPS.
Whether cigarette shipment gains persist after inventory effects fade, and whether pricing continues to offset category-volume pressure.
The timing, amount and collectability of tobacco litigation, Engle settlement and NPM Adjustment obligations or recoveries.
Cash-flow coverage of dividends, repurchases, debt service and settlement payments, given the working-capital deficit and lower cash balance.
Whether regulatory changes, excise taxes, or competition in e-vapor and other tobacco alternatives materially alter demand or costs.