Altria Group, Inc. — Q3 2016 Form 10-Q
Business context and period. Unaudited results cover the three and nine months ended September 30, 2016, compared with the same 2015 periods. Altria’s principal businesses include U.S. smokeable and smokeless tobacco, wine, innovative tobacco products and finance assets. Its approximately 27% SABMiller investment was accounted for under the equity method at quarter-end.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenues | $6.905B | $6.699B | $19.492B | $19.116B |
| Gross profit | $3.150B | $3.046B | $8.763B | $8.392B |
| Operating income | $2.382B | $2.307B | $6.769B | $6.396B |
| Net earnings attributable to Altria | $1.093B | $1.528B | $3.963B | $3.994B |
| Diluted EPS | $0.56 | $0.78 | $2.02 | $2.03 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $3.500B | $4.090B |
Net revenues include excise taxes billed to customers; excise taxes are presented separately in the income statement. Gross profit was approximately 45.6% of net revenues in Q3 and 45.0% for the nine-month period; operating margin on that same basis was approximately 34.5% and 34.7%, respectively.
- Balance sheet and liquidity: At September 30, cash was $2.298B, total assets $32.934B, total liabilities $29.951B and total equity $2.947B. Long-term debt was $13.878B, up from $12.843B at year-end 2015; there was no short-term borrowing. Current liabilities were $6.895B, including $3.429B in accrued settlement charges and $1.193B in dividends payable.
- Cash flows: Nine-month operating cash flow fell $590M year over year, primarily reflecting a $500M voluntary pension contribution and higher tobacco-litigation payments. Investing activities provided $35M; financing used $3.606B, including $3.321B of common dividends and $512M of share repurchases. Cash declined $71M from year-end.
- Debt and access to liquidity: Altria issued $2.0B of senior notes in September and repurchased $933M principal of notes in a tender offer. The resulting $823M pretax early-extinguishment loss was recognized in Q3. The company reported $3.0B available under its revolving credit agreement and stated it expected to meet covenants; debt/EBITDA was 1.5x and EBITDA/interest was 13.0x.
Changes versus the prior comparable period
- For the nine months, revenue rose 2.0% and operating income rose 5.8%, while attributable net earnings fell 0.8% and diluted EPS fell 0.5%. Operating gains were driven mainly by smokeable and smokeless products, higher SABMiller equity earnings and improved financial-services results.
- In Q3, revenue rose 3.1% and operating income rose 3.3%, but attributable net earnings declined 28.5% and diluted EPS declined 28.2%. The principal reported-earnings drag was the $823M debt-extinguishment loss; higher operating income, SABMiller earnings and derivative gains partly offset it.
- Smokeable segment nine-month revenue increased 0.9% and operating companies income increased 2.1%, despite total shipment volume declining 1.6%. Smokeless revenue increased 9.8% and operating companies income increased 12.0%, with shipment volume up 5.9%. Wine revenue increased 8.0%, while operating companies income increased 3.1%.
- Operating cash flow was lower than in 2015. Total debt increased by approximately $1.0B from December 31, 2015.
Outlook, management commentary and material events
- Guidance: Management reaffirmed forecast 2016 adjusted diluted EPS growth of 6.5%–8.5% over 2015 adjusted diluted EPS. This is a non-GAAP outlook; management did not provide a corresponding GAAP EPS forecast or reconciliation because excluded items are difficult to predict and may be significant.
- SABMiller transaction, subsequent event: AB InBev completed its combination with SABMiller on October 10, 2016. Altria received approximately $4.8B pretax cash and restricted shares, plus approximately $0.5B from exercising currency options; it subsequently invested about $1.6B in AB InBev shares. Ownership was approximately 10.2% as of October 24. Management estimated a total pretax gain of approximately $13.7B, or $8.9B after tax, with substantially all expected in Q4 2016. The restricted shares are subject to a five-year lock-up ending October 10, 2021. Altria expects equity-method accounting and a one-quarter reporting lag.
- Capital returns: The quarterly dividend rate increased 8% to $0.61 per share, or $2.44 annualized. Management cited a target payout ratio of approximately 80% of adjusted diluted EPS. In October, the board expanded the share-repurchase authorization from $1B to $3B, with completion expected by the end of Q2 2018; repurchases remain discretionary.
- Restructuring and efficiencies: The productivity initiative was expected to generate approximately $300M in annualized savings by the end of 2017, with approximately $140M in total pretax restructuring charges. Separately, an October 2016 facilities consolidation was expected to deliver approximately $50M in annualized savings by the end of 2018, with approximately $150M in pretax charges, about $90M of which are expected to be cash expenditures.
- Key risks and contingencies: The filing describes extensive tobacco-related litigation, including Engle progeny cases, MSA/NPM adjustment disputes and other product claims. Management said it had not concluded that losses were probable and estimable for pending tobacco-related cases generally, so no general provision was recorded; specific litigation charges and settlements were recognized. Other risks include FDA regulation and product-authorization requirements, excise-tax increases, declining cigarette consumption, down-trading and illicit trade, competition, and agricultural supply and cost changes. Altria also identified currency, integration, tax-treatment and restricted-share risks related to its AB InBev investment.
Important facts for investors to verify
- How much of 2016 adjusted EPS guidance depends on underlying operating performance versus exclusions, including the Q4 transaction gain and debt-related or restructuring items.
- The final amount, timing, tax treatment and accounting for the SABMiller/AB InBev gain, cash proceeds, dividends and equity-method earnings.
- Whether tobacco litigation outcomes, MSA/NPM disputes or settlement-payment changes result in material additional charges, cash payments or recoveries.
- Whether tobacco shipment trends, pricing and market-share performance—particularly cigarette volume declines and smokeless growth—continue as management described.
- Progress against the stated restructuring savings, associated cash charges, debt levels, pension funding needs and dividend/repurchase plans.