Altria Group, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited results; dollar amounts are in millions unless stated otherwise. Altria’s businesses include smokeable tobacco, smokeless tobacco and wine, alongside financial services and an approximately 10.1% equity-method investment in AB InBev.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net revenues | $6,837 | $6,729 | $19,250 | $19,475 |
| Gross profit | $3,255 | $3,171 | $9,332 | $9,061 |
| Operating income | $2,557 | $2,589 | $7,371 | $7,356 |
| Net earnings attributable to Altria | $1,943 | $1,866 | $5,713 | $5,256 |
| Diluted EPS | $1.03 | $0.97 | $3.02 | $2.72 |
| Dividends declared per share | $0.80 | $0.66 | $2.20 | $1.88 |
- Approximate gross margin was 47.6% in Q3 (47.1% prior year) and 48.5% for nine months (46.5% prior year); operating margin was 37.4% in Q3 (38.5%) and 38.3% for nine months (37.8%).
- For nine months, operating cash flow was $6,566 versus $4,144; investing cash use was $137 versus $202; and financing cash use was $5,251 versus $5,950. Management attributed the operating cash flow increase primarily to lower settlement and income-tax payments.
- At September 30, cash and cash equivalents were $2,393; cash, cash equivalents and restricted cash totaled $2,492. Total debt was approximately $13.9 billion, comprising $2,007 current and $11,896 long-term debt. Altria had no short-term borrowings and $3.0 billion available under its revolving credit facility.
- Current liabilities were $8,646 against current assets of $5,165, including $3,230 of accrued settlement charges and $1,508 of dividends payable. Management said it could fund its working-capital deficit through operating cash flow and/or short-term borrowing.
- Under the revolving-credit covenant, the EBITDA-to-interest ratio was 14.8x against a 4.0x minimum; Altria reported compliance. Credit ratings were A3/A-/A- for long-term debt, all with stable outlooks.
Material changes versus the prior comparable period
- Nine-month revenue declined 1.2%, while operating income was nearly flat, up 0.2%. Net earnings attributable to Altria rose 8.7% and diluted EPS rose 11.0%, primarily reflecting a lower tax rate and higher AB InBev equity earnings, partly offset by the absence of a 2017 AB InBev/SABMiller transaction gain.
- Q3 revenue rose 1.6%, but operating income fell 1.2%. Net earnings attributable to Altria increased 4.1% and diluted EPS increased 6.2%, primarily due to the lower tax rate and fewer shares outstanding.
- The nine-month effective tax rate fell 6.1 percentage points to 25.1%; Q3’s rate fell 3.9 points to 25.5%. The 2018 rate benefited chiefly from the Tax Cuts and Jobs Act reduction in the federal corporate rate to 21%, while tax adjustments related to foreign tax credits and deemed repatriation partly offset the benefit.
- Smokeable-products revenue declined 2.1% for nine months; segment operating companies income was essentially unchanged. Cigarette shipments fell 6.3%, and total cigarette retail share declined 0.6 percentage points to 50.2% for the nine-month period. Smokeless revenue rose 7.0% and segment income rose 15.3%, principally on pricing and lower facility-consolidation costs. Wine revenue increased 3.8%, but segment income declined 11.0%.
- Marketing, administration and research costs increased 16.5% for nine months, reflecting higher smokeable-segment costs, including litigation items, and greater investment in innovative tobacco products. The corresponding Q3 increase was 22.0%.
Outlook, management commentary and significant risks
- Guidance: In October 2018, Altria raised the lower end of its 2018 adjusted diluted EPS growth outlook to 16.5%–19% over its 2017 adjusted EPS base of $3.39. It forecast an adjusted effective tax rate of approximately 23%–24%. Guidance excludes specified items, and management did not provide a GAAP reconciliation because those items are difficult to predict and may be significant.
- Altria said its 2018 plans included reinvesting approximately one-third of the tax-reform benefit, with investment in innovative products, regulatory science, brand equity, retail fixtures and future retail concepts. It expects the completed manufacturing-facility consolidation to generate approximately $50 million in annualized savings by year-end 2018.
- AB InBev exposure: At September 30, Altria’s investment fair value was $17.2 billion versus a $17.8 billion carrying value, and its value continued to fall afterward. AB InBev’s October 25 announcement of a 50% dividend reset was expected to reduce Altria’s cash dividends; the investment’s reported fair value on that date was approximately $14.5 billion. Altria concluded the decline was temporary and recorded no impairment. Management did not expect the dividend reduction to materially affect Altria’s liquidity, earnings or financial position.
- Regulation and product risk: The FDA was considering actions on underage e-vapor use and potential standards for nicotine and flavors, including menthol. In October, Altria said Nu Mark would remove its pod-based e-vapor products pending authorization or resolution of the youth-use issue and discontinue non-tobacco, non-menthol and non-mint flavors. Altria did not expect these steps to have a material financial effect.
- Litigation and settlement exposure: Altria disclosed extensive tobacco litigation, including approximately 2,200 pending state Engle progeny cases as of October 22, 2018. It stated that losses in pending tobacco cases generally were not considered probable or reasonably estimable, so no provision was recorded for those potential outcomes; adverse outcomes could nevertheless materially affect results, cash flow or financial position. PM USA had posted approximately $99 million of cash-collateralized appeal bonds. The filing also describes ongoing disputes over Master Settlement Agreement NPM adjustments and related state payments.
- Other principal risks include declining cigarette consumption, competitive and price pressures, excise-tax increases, illicit trade, evolving consumer preferences, potential product recalls, supply or facility disruptions, cyber incidents, and changes in the value or earnings of the AB InBev investment.
Most important facts for investors to verify
- Whether cigarette shipment and share declines continue, and whether pricing offsets volume losses without further margin pressure.
- How actual adjusted EPS and tax results compare with the 2018 guidance, including excluded items and the effects of tax-law adjustments.
- Whether the AB InBev share-price decline leads to an impairment, and how its dividend reset affects cash received by Altria.
- Developments in tobacco litigation, appeal-bond requirements, NPM adjustment disputes and the $3.23 billion accrued settlement-charge balance.
- The financial and market consequences of FDA action on e-vapor products, flavors, nicotine levels and product authorization.
- Whether operating cash flow remains sufficient to support settlement payments, the increased dividend, repurchases and debt obligations.