Altria Group, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2019, compared with the same periods in 2018. Altria’s principal businesses are U.S. smokeable tobacco, smokeless tobacco and wine; its investments include ABI, JUUL and Cronos.
Key financial results
| Metric | Three months ended Sept. 30, 2019 | Nine months ended Sept. 30, 2019 |
|---|---|---|
| Net revenues | $6.856 billion; +0.3% year over year | $19.103 billion; -0.8% |
| Gross profit | $3.497 billion | $9.627 billion |
| Operating income | $2.944 billion; +15.1% | $7.899 billion; +7.2% |
| Net earnings (loss) attributable to Altria | $(2.600) billion, vs. $1.943 billion | $516 million, vs. $5.713 billion |
| Basic and diluted EPS | $(1.39), vs. $1.03 | $0.27, vs. $3.02 |
| Operating cash flow | Not presented separately for the quarter | $5.274 billion, vs. $6.566 billion |
Gross margin, calculated as gross profit divided by reported net revenues, was approximately 51.0% for the quarter and 50.4% for the nine-month period. Net revenues include excise taxes billed to customers.
Cash, debt and liquidity. Cash and cash equivalents were $1.604 billion at September 30, 2019. Total debt was approximately $27.9 billion, compared with $25.7 billion at year-end 2018; no short-term borrowings were outstanding. Current assets of $4.291 billion were below current liabilities of $7.662 billion. Management said it expects operating cash flow and access to capital markets and credit to fund working capital and ongoing needs. The undrawn revolving credit facility was $3.0 billion; Altria reported covenant compliance and an 8.7-to-1.0 EBITDA-to-interest ratio against a 4.0-to-1.0 minimum.
Investing cash outflow was $2.412 billion, primarily reflecting the Cronos investment and Burger Group acquisition. Financing cash outflow was $2.650 billion. The company paid $4.498 billion in common dividends during the nine months. The Board raised the quarterly dividend 5% to $0.84 per share, or $3.36 annualized; future payments remain at the Board’s discretion.
Material changes and operating trends
- GAAP earnings were dominated by a $4.5 billion non-cash impairment of Altria’s JUUL investment. Altria valued its 35% economic interest at $8.3 billion, about 35% below its $12.8 billion carrying value, citing regulatory and market deterioration, lower expected volumes and delayed margin improvement. A full $1.040 billion tax valuation allowance was recorded against the related deferred tax asset.
- Cronos-related financial instruments generated a $1.327 billion mark-to-market loss for the nine months ($636 million in Q3). Management’s reconciliation describes net Cronos-related special-item expense of $1.093 billion for the nine months, after related equity-investment earnings.
- Operating income increased despite slightly lower nine-month revenue, helped by improved smokeable and smokeless segment results, lower marketing and administrative spending, and reduced innovative-product spending. Interest and other debt expense nearly doubled year over year to $989 million for the nine months, primarily due to borrowing for the JUUL and Cronos transactions.
- Smokeable segment revenue fell 0.9% over nine months as cigarette shipments declined 6.9%; operating companies income rose 5.3%, mainly on pricing and lower costs. Marlboro retail share was 43.2% for the nine months, down 0.1 percentage point.
- Smokeless segment revenue rose 4.3% and operating companies income rose 10.1% for nine months, primarily on pricing, while shipment volume declined 2.8%. Wine revenue declined 1.2% and operating companies income fell 31.5%.
- Operating cash flow declined by $1.292 billion year over year, principally due to higher settlement payments, lower ABI dividends and higher interest payments.
Outlook, management commentary and risks
Altria reaffirmed 2019 adjusted diluted EPS growth guidance of 5%–7% over its 2018 adjusted EPS base of $3.99, and an adjusted effective tax-rate range of 23.5%–24.5%. Guidance assumes little-to-no adjusted earnings or cash contribution from JUUL and Cronos. It incorporates higher interest expense, lower ABI dividends, IQOS launch investment and cost-reduction savings expected to reach an annualized approximately $575 million by year-end. Adjusted guidance excludes specified special items and has no corresponding GAAP reconciliation.
Management estimated U.S. cigarette industry volume would decline 5%–6% in 2019 and average a 4%–6% annual decline through 2023. It noted that these estimates may change with consumer response to regulation and health concerns. Regulatory actions were a significant uncertainty: possible restrictions or bans on flavored e-vapor products, product-authorization deadlines, state and local restrictions, and vaping-related adverse publicity could further affect JUUL and Altria’s investment.
Other material risks include extensive tobacco litigation and possible adverse judgments, FDA and other regulation, excise taxes, declining cigarette consumption, competitive and pricing pressures, and changes in ABI’s value or dividends. Management reported that pending litigation losses were generally not considered probable or reasonably estimable; the filing describes possible material effects from adverse outcomes. Tobacco and health litigation liability was $9 million at period-end, distinct from $3.094 billion of accrued settlement charges. State settlement and FDA user-fee charges were estimated at approximately $4.4 billion for 2019 and $4.5 billion annually thereafter, subject to adjustment.
Altria reported that JUUL share conversion remained subject to FTC antitrust review; the company and JUUL certified substantial compliance with the FTC’s additional-information request on October 30, 2019. The filing also notes a shareholder class action filed in October 2019 concerning statements about the JUUL investment and ongoing e-vapor litigation.
Most important facts for investors to verify
- Whether JUUL’s regulatory, volume and margin outlook supports its $8.3 billion valuation, and whether further impairment is likely.
- How Cronos derivative fair-value changes affect reported earnings versus underlying operating results.
- Whether cigarette shipment and industry-volume declines, pricing, and market-share trends remain consistent with management’s forecast.
- Debt-service capacity, refinancing terms, dividend sustainability and the effect of settlement payments on cash flow.
- Developments in FTC review, FDA policy and deadlines, tobacco litigation, and ABI’s market value and dividends.