Altria Group, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; unaudited. Altria’s businesses include U.S. cigarettes and cigars, smokeless tobacco, wine, innovative tobacco products and finance assets. It also held approximately 27% of SABMiller.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenues | $6.521 billion | $6.613 billion | $12.587 billion | $12.417 billion |
| Operating income | $2.410 billion | $2.224 billion | $4.387 billion | $4.089 billion |
| Net earnings attributable to Altria | $1.653 billion | $1.448 billion | $2.870 billion | $2.466 billion |
| Diluted EPS | $0.84 | $0.74 | $1.47 | $1.25 |
| Dividends declared per share | $0.565 | $0.52 | $1.13 | $1.04 |
- Q2 revenue declined 1.4%, while six-month revenue increased 1.4%. Operating income rose 8.4% in Q2 and 7.3% year to date; attributable earnings rose 14.2% and 16.4%, respectively.
- Calculated operating margin was approximately 36.9% in Q2 versus 33.6% a year earlier, and 34.8% for the first half versus 32.9%. Gross margin, calculated using reported gross profit divided by net revenues, was approximately 45.3% in Q2 versus 43.4%, and 44.6% for the first half versus 43.1%.
- First-half operating cash flow was $1.058 billion, down from $1.247 billion. Investing cash use was $63 million; financing cash use was $2.545 billion, including $2.215 billion in common dividends and $341 million in share repurchases. Cash declined by $1.550 billion to $819 million.
- At June 30, cash was $819 million, current assets $4.600 billion and current liabilities $5.512 billion, a working-capital deficit of about $912 million. Long-term debt was $12.837 billion; there were no short-term borrowings. Management said liquidity and access to financing were adequate for anticipated needs.
- The $3.0 billion revolving credit facility was undrawn. Covenant ratios were 1.4x debt/EBITDA against a 3.0x maximum and 12.8x EBITDA/interest against a 4.0x minimum. Credit ratings were upgraded in Q1 2016; outlooks were stable.
Business changes and comparability
- Smokeable products first-half revenue increased 0.5% and operating companies income increased 4.3%; Q2 revenue declined 2.4%, while operating companies income increased 4.6%. Cigarette shipment volume fell 2.1% in the first half and 5.0% in Q2, with declines driven mainly by industry volume trends. Marlboro retail share was broadly stable.
- Smokeless products first-half revenue rose 10.0% and operating companies income 13.6%; Q2 increases were 8.7% and 15.4%. First-half shipment volume rose 6.0%, led by Copenhagen; Copenhagen and Skoal combined retail share gained 0.9 percentage point.
- Wine revenue grew 7.1% in the first half, while operating companies income was unchanged. Ste. Michelle acquired substantially all assets of Patz & Hall in April; higher volume was offset by costs, including acquisition-related costs.
- First-half results included a $157 million pre-tax gain on a currency put option related to the proposed SABMiller transaction and $124 million of productivity-initiative charges. 2015 comparisons included a $228 million debt-extinguishment loss. SABMiller equity earnings fell 26.2% in the first half, primarily reflecting higher special items.
- Operating cash flow was lower year over year, principally due to higher litigation and settlement payments and working-capital timing. The company paid $1.326 billion of accrued settlement charges during the first half.
Outlook, management commentary and risks
- In July 2016, Altria raised its 2016 adjusted diluted EPS growth forecast to 7.5%–9.5% over 2015 adjusted EPS. It expected a 35.3% full-year effective tax rate on operations. These are non-GAAP measures that exclude specified items; the filing does not provide a corresponding GAAP reconciliation because excluded items are difficult to forecast.
- The productivity initiative is expected to generate approximately $300 million of annualized savings by the end of 2017. Altria expected about $140 million in total pre-tax restructuring charges, substantially all in 2016 and largely cash expenditures.
- Management’s dividend payout target remained approximately 80% of adjusted diluted EPS. The annualized dividend rate was $2.26 per share; future dividends and repurchases remain subject to Board discretion. About $624 million remained under the $1.0 billion repurchase authorization at quarter-end, with completion expected by year-end 2016.
- AB InBev revised its SABMiller offer on July 26, after quarter-end. Altria had elected the partial-share alternative and expected, if completed, to receive restricted shares representing about 10.5% of NewCo plus approximately $3.0 billion pre-tax cash. Altria estimated a one-time gain of about $13 billion pre-tax, or $8.5 billion after tax, but actual results could vary significantly. Closing remained subject to shareholder and regulatory approvals; the shares would be subject to transfer restrictions.
- Material risks include extensive tobacco litigation, including Engle progeny claims; regulatory actions, including FDA rules extending to cigars and e-vapor products in August 2016; excise-tax increases; declining cigarette volumes, down-trading and illicit trade; and potential SABMiller transaction, currency and valuation risks. Management stated that losses in pending tobacco cases were generally not considered probable or estimable, except for recorded provisions, so possible exposure may not be reflected in accrued liabilities.
- Other notable exposure includes $2.264 billion of accrued settlement charges at June 30 and ongoing disputes over Master Settlement Agreement non-participating-manufacturer adjustments. The company estimated State Settlement Agreement and FDA user-fee charges of approximately $4.9 billion in 2016 and each year thereafter, subject to adjustment.
Important facts for investors to verify
- Whether the 7.5%–9.5% adjusted EPS growth outlook is achieved, and how excluded items affect reported GAAP results.
- Progress and final economics of the AB InBev–SABMiller transaction, including closing approvals, share proration, currency exposure and the estimated accounting gain.
- Developments in tobacco litigation and MSA/NPM disputes, including cash payments, appeals and potential changes to recorded provisions.
- Whether cigarette volume and market-share trends, smokeless growth and productivity savings support operating performance and dividend coverage.
- Liquidity and cash flow after dividends, settlement payments and repurchases, alongside debt levels and credit ratings.