ALTRIA GROUP, INC. quarterly report, Q1 FY2019

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Altria Group, Inc. — Q1 2019 Form 10-Q

Reporting period: Three months ended March 31, 2019; comparisons are with the three months ended March 31, 2018 unless otherwise noted. Unaudited consolidated financial statements. Altria’s principal businesses include U.S. tobacco and wine, alongside equity investments in AB InBev, JUUL and Cronos.

Financial performance

  • Revenue and operating results: Net revenues were $5.628 billion, down 7.9%; gross profit was $2.811 billion, down 4.3%; and operating income was $2.238 billion, down 3.4%. Approximate gross and operating margins on reported net revenues were 49.9% and 39.8%, respectively, versus 48.1% and 37.9% a year earlier.
  • Earnings: Net earnings attributable to Altria were $1.120 billion, down 40.9%; basic and diluted EPS were $0.60, versus $1.00. Results included a $425 million pre-tax loss on Cronos-related financial instruments, lower AB InBev equity earnings ($86 million versus $342 million), and higher interest and debt expense ($384 million versus $166 million).
  • Cash flow: Operating cash flow was $2.289 billion, compared with $2.809 billion. Investing used $1.950 billion, primarily reflecting the $1.831 billion Cronos investment. Financing provided $1.683 billion, including $16.265 billion of long-term debt issuance and repayment of $12.800 billion of short-term borrowings. Cash and cash equivalents ended the quarter at $3.352 billion.
  • Debt and liquidity: Total debt was $29.2 billion at quarter-end, versus $25.7 billion at December 31, 2018; no short-term borrowings remained. The February issuance of dollar- and euro-denominated notes refinanced the term loan and funded Cronos and other purposes. Altria reported a $3.0 billion undrawn revolving credit facility and compliance with its covenants; its rolling EBITDA-to-interest covenant ratio was 10.9x against a 4.0x minimum. Current liabilities exceeded current assets by about $3.9 billion.
  • Capital returns: Dividends declared were $0.80 per share; cash dividends paid were $1.502 billion. The annualized dividend rate was $3.20 per share, and management cited an approximately 80% adjusted-EPS payout target. The company repurchased $151 million of shares during the quarter.

Material changes and business trends

  • Smokeable products: Segment revenue was $4.935 billion, down 8.8%, and operating companies income was $1.932 billion, down 5.2%. Reported cigarette shipments fell 14.3%; management estimated a 7% decline after adjusting for trade inventory movements and one fewer shipping day. Marlboro retail share was 43.1%, down 0.2 percentage points.
  • Smokeless products: Revenue rose 2.9% to $540 million and operating companies income rose 5.9% to $358 million, primarily on pricing and lower costs. Shipment volume declined 2.2%; total retail share increased 0.1 percentage point to 53.9%.
  • Wine: Revenue increased 6.3% to $151 million, while operating companies income declined 11.8% to $15 million, reflecting higher costs and promotional spending. Shipment volume increased 8.0%.
  • Consolidated revenue declined mainly because of lower smokeable-product shipments. Lower marketing, administration and research spending partly offset weaker smokeable results. The 2018 comparison also included $68 million of favorable NPM adjustment items.

Investments, outlook and management commentary

  • Altria held a 10.1% interest in AB InBev, carried at $17.476 billion. Its reported fair value was $16.6 billion at March 31, 2019; management concluded the shortfall was temporary and recorded no impairment. AB InBev had reduced its dividend by 50% in 2018, lowering expected cash distributions to Altria.
  • Altria’s 35% JUUL investment remained non-voting pending antitrust clearance and was carried at its $12.8 billion cost. In April 2019, Altria received an FTC second request for information, extending the review. The investment is subject to transfer and non-competition restrictions.
  • Altria completed its 45% Cronos investment in March for approximately $1.8 billion. The investment included warrants and anti-dilution rights; their fair-value changes contributed to the quarter’s $425 million pre-tax financial-instrument loss. No Cronos equity earnings were recorded in Q1 because results are reported on a one-quarter lag.
  • Management reaffirmed 2019 adjusted diluted EPS growth guidance of 4%–7% over the 2018 adjusted base of $3.99, and an adjusted effective tax-rate range of 23.5%–24.5%. Guidance excludes specified special items and assumes little-to-no earnings or cash contributions from JUUL and Cronos. It reflects higher interest costs, lower AB InBev dividends, cost savings and planned IQOS launch investment, subject to FDA authorization. Management expected the cost-reduction program to reach approximately $575 million in annualized savings by year-end 2019.
  • Altria revised its 2019 estimated U.S. cigarette-industry volume decline to 4%–5% from 3.5%–5%, and maintained an estimated 4%–5% average annual decline over the next five years.

Risks, contingencies and unusual items

  • Key risks include declining cigarette consumption, competition and consumer shifts, excise taxes, and extensive tobacco regulation. FDA actions under consideration include restrictions on flavored products, potential menthol or cigar flavor standards, and tighter e-vapor rules; regulatory action could limit product sales or increase costs.
  • Altria faces substantial tobacco-related litigation, including approximately 2,000 pending state Engle progeny cases as of April 22, 2019. Management stated it had not concluded losses were probable or reasonably estimable for pending tobacco cases generally, so no general provision was recorded; adverse verdicts or changes in appeal-bond requirements could materially affect results or cash flows.
  • Accrued settlement charges were $4.367 billion at March 31, 2019, up from $3.454 billion at year-end. State settlement payments and FDA user fees generated approximately $1.0 billion of first-quarter cost-of-sales charges. Estimated annual charges for these obligations were approximately $4.7 billion in 2019 and 2020, subject to volume, market-share and other adjustments.
  • Q1 included $159 million of asset impairment, exit, implementation and acquisition-related costs in MD&A (including $98 million of acquisition-related costs), as well as Cronos-related derivative and foreign-exchange losses. Altria adopted the new lease standard; the reported impact was not material.

Important facts for investors to verify

  • Whether cigarette shipment and retail-share declines stabilize, and whether pricing can offset volume pressure.
  • FTC clearance and the eventual accounting, valuation and commercial performance of JUUL; also FDA actions affecting e-vapor and other tobacco products.
  • Cronos operating performance, regulatory exposure and the volatility of the related warrant and preemptive-right valuations.
  • AB InBev dividends, share value and impairment exposure, alongside Altria’s elevated debt, interest expense and refinancing capacity.
  • Developments in Engle progeny and other litigation, settlement accruals, and the assumptions underlying management’s adjusted EPS guidance and cost-savings outlook.