Altria Group, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited results for the quarter and nine months ended September 30, 2014. Altria’s businesses include U.S. smokeable and smokeless tobacco, wine, innovative tobacco products, and finance leases; it also holds approximately 27% of SABMiller and accounts for that investment under the equity method.
Financial performance and position
| Metric | Nine months 2014 | Prior comparable period |
|---|---|---|
| Net revenue | $18.264 billion | $18.386 billion |
| Gross profit | $7.533 billion | $8.049 billion |
| Operating income | $5.708 billion | $6.285 billion |
| Net earnings attributable to Altria | $3.834 billion | $4.047 billion |
| Diluted EPS | $1.93 | $2.02 |
| Operating cash flow | $3.060 billion | $2.859 billion |
For the third quarter, revenue was $6.491 billion versus $6.553 billion; operating income was $1.999 billion versus $2.132 billion; net earnings were $1.397 billion versus $1.396 billion; and diluted EPS was $0.71 versus $0.70. Gross margin was approximately 41.2% for both the nine-month and third-quarter periods in 2014, compared with approximately 43.8% and 43.0%, respectively, in 2013.
Nine-month investing cash flow was positive $60 million and financing cash flow was negative $4.054 billion. Cash fell to $2.241 billion from $3.175 billion at year-end 2013. Total debt was approximately $14.0 billion, down from $14.5 billion; $1.3 billion was classified as current. Management reported a working-capital deficit but said operating cash flow and borrowing capacity were expected to fund it. The $3.0 billion revolving credit facility was undrawn and available; covenant ratios were within requirements.
Changes versus prior comparable periods
- Nine-month revenue declined 0.7%, operating income 9.2%, net earnings 5.3%, and diluted EPS 4.5%. Operating-income comparability was materially affected by larger 2013 non-participating manufacturer (NPM) settlement recoveries: $664 million in 2013 versus $90 million of NPM-related income in 2014.
- Third-quarter net earnings were essentially flat and diluted EPS increased 1.4%, primarily reflecting fewer shares outstanding and lower interest expense. Lower operating income was offset by higher SABMiller equity earnings, lower interest expense, and a lower tax rate.
- Operating cash flow improved by $201 million, chiefly because 2013 included a voluntary $350 million pension contribution; higher settlement payments in 2014 partly offset that improvement.
- Nine-month smokeable-segment operating income declined to $5.160 billion from $5.471 billion, including the prior-year NPM recovery comparison. Smokeless operating income rose to $804 million from $769 million, and wine operating income rose to $81 million from $73 million.
Outlook, management commentary, risks and unusual items
- Management reaffirmed 2014 reported diluted EPS guidance of $2.54–$2.59 and adjusted diluted EPS growth of 7%–9% over 2013 adjusted EPS. Adjusted EPS is a non-GAAP measure. Management expected stronger adjusted EPS growth in the fourth quarter, citing tax-rate comparisons and the end of federal tobacco quota buy-out payments.
- The quarterly dividend was raised 8.3% to $0.52 per share, or $2.08 annualized. Management cited an approximately 80% target payout ratio of adjusted diluted EPS. The board retains discretion over future dividends. Altria repurchased $679 million of shares in the first nine months; approximately $778 million remained under the new $1.0 billion program at quarter-end.
- Green Smoke’s e-vapor business was acquired in April for up to approximately $130 million, subject to adjustments and contingent consideration. The acquisition added $111 million of preliminary goodwill; acquisition and integration costs were $23 million for the nine months. Purchase accounting remained subject to finalization.
- UST’s $300 million notes were scheduled for redemption on October 29, 2014. Management expected a roughly $45 million pretax early-extinguishment loss in the fourth quarter.
- Key risks include extensive tobacco litigation, changing FDA and other regulation, excise taxes, declining cigarette industry volume, competition and evolving consumer preferences, and tobacco-leaf supply and cost. Management said losses in pending tobacco cases were not considered probable or reasonably estimable, so no provision was recorded for those possible outcomes. The filing describes substantial potential exposure, including the stayed $10.1 billion Price judgment in Illinois and continuing Engle progeny litigation. The $3.139 billion accrued settlement-charges balance and ongoing state settlement payments warrant attention.
- State settlement agreements, FETRA and FDA user fees generated approximately $3.7 billion of cost-of-sales charges in the first nine months. FETRA obligations expired after the third quarter; estimated annual charges for these programs were approximately $5 billion in 2014 and $4.6 billion thereafter, subject to variable factors and assumptions.
Important facts for investors to verify
- Reconcile reported EPS with management’s adjusted EPS outlook, including NPM settlement items, litigation charges, acquisition costs, tax items, and the expected debt-redemption loss.
- Monitor cigarette shipment declines, pricing, market-share trends, and whether smokeless and wine growth can offset pressure in smokeables.
- Track the resolution of the Price appeal, Engle progeny cases, and NPM disputes; the timing and financial impact of adverse outcomes are uncertain.
- Check settlement-related cash payments, the working-capital deficit, near-term debt maturities, and progress on share repurchases and dividends.
- Confirm the final Green Smoke purchase accounting and the effect of proposed FDA rules on e-vapor products and other tobacco categories.