Business context and reporting period
Altria Group, Inc.’s Form 10-K covers the fiscal year ended December 31, 2014; it is an annual filing, not a quarterly report. Altria’s principal businesses are U.S. cigarettes, cigars and pipe tobacco, smokeless tobacco, wine, innovative tobacco products and a shrinking finance-lease portfolio. It also held approximately 27% of SABMiller and accounted for the investment under the equity method.
Financial performance and position
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Net revenues | $24.522 billion | $24.466 billion | Essentially flat |
| Operating income | $7.620 billion | $8.084 billion | Down 5.7% |
| Earnings before income taxes | $7.774 billion | $6.942 billion | Up 12.0% |
| Net earnings attributable to Altria | $5.070 billion | $4.535 billion | Up 11.8% |
| Diluted EPS | $2.56 | $2.26 | Up 13.3% |
| Net cash from operations | $4.663 billion | $4.375 billion | Up $288 million |
| Capital expenditures | $163 million | $131 million | Up 24.4% |
| Total debt at year-end | $14.693 billion | $14.517 billion | Up $176 million |
The reported pre-tax profit margin was 31.7%, versus 28.4% in 2013. Operating income declined despite higher net earnings, primarily because 2013 included larger benefits from NPM adjustment items; 2014 earnings also benefited from materially lower debt-extinguishment losses and interest expense. Net revenues include excise taxes billed to customers.
At December 31, 2014, cash and cash equivalents were $3.321 billion; current assets were $6.878 billion and current liabilities $7.673 billion, a working-capital deficit of approximately $795 million. Management said it expected to fund working-capital needs from operating cash flow and/or commercial paper. A $3.0 billion revolving credit facility was undrawn; covenant ratios were 1.8x debt to EBITDA and 9.7x EBITDA to interest, within the respective limits of 3.0x maximum and 4.0x minimum. Credit ratings were investment grade with stable outlooks.
Altria declared $2.00 per share in dividends for 2014, representing 78.1% of basic and diluted EPS; dividends paid were approximately $3.9 billion. The quarterly dividend was increased 8.3% to $0.52 per share in the third quarter. Share repurchases cost $939 million during 2014, and approximately $518 million remained under the $1.0 billion July 2014 program. Stockholders’ equity declined to $3.010 billion from $4.118 billion.
Fourth-quarter data
Unaudited fourth-quarter 2014 net revenues were $6.258 billion, net earnings were $1.236 billion and diluted EPS was $0.63, compared with $6.080 billion, $488 million and $0.24, respectively, in fourth-quarter 2013. The prior-year quarter included a $1.084 billion pre-tax loss on early extinguishment of debt.
Segment results
- Smokeable products: 2014 revenue was $21.939 billion and operating companies income was $6.873 billion, down 2.7%. Cigarette shipments declined 3.0% to 125.4 billion units; Marlboro retail share rose to 43.8% from 43.7%. Lower volume and the absence of the larger 2013 NPM adjustment benefit weighed on income, partly offset by pricing.
- Smokeless products: Revenue was $1.809 billion and operating companies income $1.061 billion, up 3.7%. Shipment volume increased 0.7% to 793.3 million units. Copenhagen gained share, while Skoal lost share; management estimated category volume growth slowed to about 2% from 5.5% in 2013.
- Wine: Revenue was $643 million and operating companies income $134 million, up 5.6% and 13.6%, respectively. Shipments rose 4.8% to 8.4 million cases, led by 14 Hands and Chateau Ste. Michelle.
- All other: Operating companies reported a loss of $185 million, compared with income of $157 million in 2013, reflecting higher investment spending in innovative tobacco products and lower finance-lease income.
Material changes versus the prior comparable period
- Operating income fell 5.7%, although net earnings increased 11.8%; the 2013 comparison included $664 million of NPM adjustment income in cost of sales and a $1.084 billion debt-extinguishment loss. The 2014 debt-extinguishment loss was $44 million.
- Operating cash flow increased to $4.663 billion from $4.375 billion. Management cited higher earnings, lower interest payments and the absence of the $350 million voluntary pension contribution made in 2013, partly offset by higher tax and settlement payments.
- Total debt increased modestly, while the weighted-average coupon rate declined to 5.7% from 5.9%. Altria issued $1.0 billion of 2.625% notes due 2020 and repaid $525 million of notes at maturity; UST also redeemed $300 million of notes.
- The 10-year FETRA tobacco quota buy-out charges expired after the third quarter of 2014, reducing 2014 cost of sales by approximately $100 million compared with a full year of obligations.
- Altria acquired Green Smoke’s e-vapor business in April 2014 for up to approximately $130 million, including contingent consideration. It recorded $28 million of integration and acquisition-related costs; the acquisition added $111 million of goodwill.
- Lower discount rates and revised mortality assumptions contributed to a pension-plan funded deficit of $1.033 billion, versus $60 million in 2013. Other comprehensive losses increased by $1.304 billion in 2014, primarily reflecting benefit-plan and SABMiller items.
Outlook, management commentary and risks
In January 2015, management forecast 2015 adjusted diluted EPS growth of 7% to 9% over 2014 adjusted diluted EPS. The forecast excludes specified special items and is not reconciled to a GAAP measure. Management expected 2015 capital expenditures of $200 million to $250 million, principally for a new USSTC manufacturing facility, and targeted a dividend payout ratio of approximately 80% of adjusted diluted EPS.
On February 25, 2015, after the fiscal year-end, PM USA reached a tentative agreement with other manufacturers to resolve approximately 415 federal Engle progeny cases. PM USA’s share is $42.5 million, to be recorded as a first-quarter 2015 pre-tax provision; the agreement is subject to approval and excludes certain cases and Florida state-court litigation.
Major risks include extensive tobacco litigation and potentially significant judgments; FDA regulation, including proposed rules covering e-vapor products and cigars; excise-tax increases; declining cigarette consumption; consumer down-trading and illicit trade; competition and changing preferences; tobacco-leaf supply and quality; and the success and regulatory treatment of new products. Management said it had not concluded that losses were probable and estimable for most pending tobacco cases and could not estimate a possible loss range. It warned that adverse litigation outcomes could materially affect results, cash flows or financial position in a particular period. The filing also identifies potential wine regulation and grape-supply risks, finance-lease credit exposure, and sensitivity of SABMiller earnings and carrying value to foreign exchange and business conditions.
Altria reported no impairment charge in its 2014 annual goodwill and indefinite-lived intangible-asset testing. However, the fair value of the Skoal trademark exceeded carrying value by approximately 17%, and that of the smokeless reporting unit by approximately 20%; management noted sensitivity to category growth, competition, regulation and other assumptions.
Most important facts for investors to verify
- How much of earnings growth reflects recurring operations versus debt-refinancing effects, tax items and NPM adjustment recoveries.
- Whether cigarette shipment declines, smokeless category slowdown and consumer shifts pressure future volume, pricing and margins.
- Progress and costs of the Green Smoke/MarkTen strategy, including regulatory requirements for e-vapor products.
- Developments in Engle progeny and other tobacco litigation, including the tentative federal settlement, appeals, bond requirements and any changes to recorded provisions.
- Execution of the 2015 EPS guidance, capital spending plan, dividend target and remaining share repurchases, alongside debt levels and pension funding needs.
- Whether smokeless-brand and reporting-unit valuations retain adequate headroom under updated operating and regulatory assumptions.