Altria Group, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also reports fourth-quarter results. Amounts are in U.S. dollars; financial figures are in millions unless noted. Net revenues include excise taxes billed to customers.
Business context and reporting period
Altria is a U.S.-focused holding company whose principal businesses are cigarettes and cigars, smokeless tobacco, wine, innovative tobacco products and a declining finance-lease portfolio. Its reportable segments are smokeable products, smokeless products and wine. In January 2017, Altria acquired Nat Sherman, which joined the smokeable products segment.
In October 2016, the AB InBev/SABMiller transaction converted Altria’s approximately 27% SABMiller stake into a 9.6% AB InBev interest. Altria then purchased additional shares for about $1.6 billion, ending 2016 with approximately 10.2% ownership. Its AB InBev investment is equity-accounted with a one-quarter lag, so no AB InBev earnings were recorded in 2016.
Key financial metrics
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net revenues | $25,744 | $25,434 |
| Operating income | $8,762 | $8,361 |
| Net earnings attributable to Altria | $14,239 | $5,241 |
| Diluted EPS | $7.28 | $2.67 |
| Net cash from operating activities | $3,791 | $5,810 |
| Capital expenditures | $189 | $229 |
| Cash and cash equivalents at year-end | $4,569 | $2,369 |
| Total debt at year-end | $13,881 | $12,847 |
Operating margin was approximately 34.0% of net revenues, versus 32.9% in 2015; gross profit was $11,591, or approximately 45.0% of net revenues. Reported pre-tax margin of 84.9% and EPS growth were exceptionally elevated by the transaction gain, rather than reflecting recurring operating performance.
Altria recorded a $13.9 billion pre-tax gain ($9.0 billion after tax) on the AB InBev/SABMiller transaction. Excluding the filing’s identified special items, its reconciliation attributes $0.17 of EPS improvement to operations and $4.61 to the transaction gain; special items overall contributed $4.25 to the reported EPS increase.
Fourth-quarter 2016 net revenues were $6,252, gross profit $2,828, net earnings attributable to Altria $10,276 and diluted EPS $5.27. The quarter included a $13.66 billion pre-tax transaction gain.
Material changes versus the prior comparable period
- Net revenues rose 1.2%; operating income rose 4.8%. Higher pricing and operating results in smokeable and smokeless products contributed, along with lower innovative-product investment spending and improved finance-services results.
- Smokeable segment operating companies income increased 2.6% to $7,768, although cigarette shipment volume fell about 2.5%. Marlboro retail share was 44.0%, unchanged, and total cigarette retail share increased 0.1 percentage point to 51.4%.
- Smokeless segment revenue rose 9.2% to $2,051 and operating companies income rose 6.2% to $1,177. Shipment volume increased 4.9%; Copenhagen and Skoal combined retail share gained 0.9 percentage point.
- Wine revenue rose 7.8% to $746 and operating companies income rose 7.9% to $164, primarily on higher shipments and improved premium mix. Shipment volume increased 5.3%.
- Operating cash flow fell by $2.0 billion, mainly due to taxes paid on transaction proceeds and related derivative gains and a $500 million voluntary pension contribution; higher dividends received from AB InBev and SABMiller partly offset the decline.
- Debt increased about $1.0 billion. Altria issued $2.0 billion of senior notes and repurchased $933 million principal amount of notes, recording an $823 million loss on early debt extinguishment.
Guidance, management commentary, risks and unusual items
- 2017 outlook: Management forecast adjusted diluted EPS growth of 7.5%–9.5% over 2016 adjusted diluted EPS and an effective tax rate on operations of approximately 36%. The forecast excludes certain potentially significant, difficult-to-predict items; the filing does not provide a corresponding GAAP EPS reconciliation.
- Cash returns and liquidity: The quarterly dividend was increased 8% in 2016 to $0.61 per share; the annualized rate was $2.44 at filing. Management targets a dividend payout ratio of approximately 80% of adjusted diluted EPS. A $3.0 billion repurchase program had about $1.935 billion remaining at year-end, with completion expected by the end of Q2 2018. Management cited adequate liquidity despite a working-capital deficit. A $3.0 billion revolving credit facility was undrawn; covenant ratios were 1.4x debt/EBITDA and 13.5x EBITDA/interest against limits of 3.0x maximum and 4.0x minimum.
- Restructuring: The facilities consolidation, expected to finish by Q1 2018, is projected to generate about $50 million annualized savings by end-2018 and approximately $150 million total pre-tax charges. A separate productivity initiative is expected to deliver about $300 million annualized savings by end-2017; its $132 million 2016 restructuring charges were substantially completed.
- Litigation and settlements: Tobacco and other litigation could materially affect results in an individual period. Management said it could not estimate possible losses for pending tobacco cases and generally had not accrued them absent probable, estimable losses. State settlement payments and FDA user fees were approximately $4.9 billion in 2016; management estimated a similar annual amount based on then-current assumptions. The filing discusses adverse verdicts, appeals and potential MSA NPM adjustment disputes.
- Regulatory and business risks: Key risks include declining cigarette industry volume, excise-tax increases and consumer down-trading, extensive FDA oversight and product-authorization requirements, competition and illicit trade. The FDA proposed a smokeless-tobacco NNN product standard in January 2017; Altria warned that a final rule in its proposed form could materially harm the business. Climate and weather, agricultural supply, distributor concentration, litigation outcomes, impairment assumptions, cyber incidents and AB InBev currency and performance also pose risks.
- Subsequent events: USSTC announced a voluntary recall of certain smokeless products in January 2017 due to product tampering; a related first-quarter charge was expected but not expected to be material. A Missouri NPM adjustment ruling could require return of approximately $19 million plus interest, subject to confirmation, with a corresponding first-quarter 2017 earnings reduction. Nu Mark recorded a $21 million provision in Q4 2016 for an e-vapor patent settlement and paid the amount in January 2017.
Important facts for investors to verify
- Reconcile GAAP EPS and earnings to recurring or adjusted performance, particularly the $13.9 billion transaction gain and other special items.
- Track operating cash flow after transaction-related tax payments and pension funding, and compare cash generation with dividends, buybacks and debt obligations.
- Assess whether the 2017 adjusted EPS growth outlook is achievable and confirm its adjusted 2016 comparison base and excluded items.
- Monitor cigarette volume and share trends, smokeless brand mix, and the sustainability of pricing-led segment earnings.
- Follow tobacco litigation, MSA NPM adjustment proceedings, FDA actions and recall developments, including their cash and earnings effects.
- Review the value, restricted-share lock-up, dividend stream and tax treatment of the AB InBev investment; its 2016 earnings contribution was nil under the one-quarter reporting lag.