ALTRIA GROUP, INC. annual report, FY2013

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Business context and reporting period

Altria Group, Inc. filed this Form 10-K for the fiscal year ended December 31, 2013. The company is a U.S.-focused holding company with smokeable products, smokeless products and wine segments, an “all other” category that includes finance leases and alternative products, and a 26.8% equity-method investment in SABMiller. Quarterly figures below are unaudited.

Financial performance and position

  • Full-year results: Net revenues were $24.466 billion, down 0.6% from 2012. Operating income rose 11.5% to $8.084 billion; earnings before taxes were $6.942 billion; net earnings attributable to Altria were $4.535 billion, up 8.5%; and diluted EPS was $2.26, up 9.7%. The reported pretax margin was 28.4% versus 26.3% in 2012.
  • Fourth quarter: Net revenues were $6.080 billion, net earnings attributable to Altria were $488 million, and diluted EPS was $0.24. The quarter included a $1.084 billion pretax loss on early extinguishment of debt.
  • Cash flow and investment: Operating cash flow was $4.375 billion, compared with $3.885 billion in 2012. Investing activities provided $602 million, including $716 million of proceeds from finance assets; capital expenditures were $131 million. Financing activities used $4.702 billion. Cash and cash equivalents ended the year at $3.175 billion.
  • Debt and liquidity: Total debt was $14.517 billion, up from $13.878 billion; long-term debt was $13.992 billion. All debt was fixed-rate, with a 5.9% weighted-average coupon. Current assets of $6.590 billion were below current liabilities of $7.058 billion, and management reported a working-capital deficit. The company had a $3.0 billion revolving credit facility, no year-end short-term borrowings, and reported covenant ratios of 1.7x debt/EBITDA and 8.4x EBITDA/interest.
  • Capital returns: Dividends paid were $3.612 billion; dividends declared were $1.84 per share. The quarterly dividend was raised 9.1% to $0.48 in the third quarter. The company repurchased 16.7 million shares for $600 million in 2013 and had approximately $457 million remaining under its share-repurchase program at year-end.
  • Segment results: Smokeable products revenue was $21.868 billion and operating companies income was $7.063 billion. Smokeless revenue was $1.778 billion and operating companies income was $1.023 billion. Wine revenue was $609 million and operating companies income was $118 million. Wine shipments rose 5.0%; smokeless shipments rose 3.2%; cigarette shipments fell 4.1% and cigar shipments fell 3.2%.

Material changes versus the prior year

  • Operating income benefited from $664 million of NPM Adjustment Items recorded as reductions to cost of sales, including $519 million from the settlement with certain states and $145 million from an arbitration ruling. These items boosted reported smokeable-segment results and are not a recurring operating trend.
  • The $1.084 billion 2013 debt-tender loss compared with an $874 million loss in 2012. Altria issued new long-term notes and used proceeds partly to fund its 2013 tender offer; total debt increased despite repayment of maturing notes.
  • Smokeable operating companies income increased 13.2%, driven by pricing and NPM Adjustment Items, partly offset by lower shipment volume. Smokeless operating companies income increased 9.9%, and wine operating companies income increased 13.5%.
  • Equity earnings from SABMiller declined 19.0% to $991 million, primarily reflecting the absence of 2012 strategic-alliance gains, partly offset by higher gains from SABMiller share issuances.
  • Operating cash flow improved, chiefly due to lower settlement and income-tax payments and a smaller voluntary pension contribution. Cash used for share repurchases was lower than in 2012.

Outlook, commentary, risks and unusual items

  • 2014 guidance: Management forecast reported diluted EPS of $2.51–$2.58 and adjusted diluted EPS growth of 6%–9% over 2013 adjusted diluted EPS. The forecast included an estimated $0.01 per share of specified expenses. Management cited premium-brand income growth, lower interest expense, a lower effective tax rate and fewer shares as expected supports, while anticipating continued investment in alternative products and variability in PMCC asset-sale gains.
  • Management expected 2014 capital expenditures of $150–$200 million. Estimated charges for State Settlement Agreements, FETRA and FDA user fees were approximately $5.0 billion in 2014 and $4.6 billion annually thereafter, subject to volume, market-share and other adjustments. FETRA obligations were expected to expire after the third quarter of 2014.
  • Nu Mark introduced MarkTen electronic cigarettes in Indiana and Arizona and planned national expansion beginning in the second quarter of 2014. In February 2014, Altria announced an agreement to acquire Green Smoke’s e-vapor business; it also entered licensing arrangements with Philip Morris International relating to e-vapor products and heated-tobacco technologies.
  • Key risks: Extensive tobacco litigation; FDA and other regulatory actions; excise-tax increases; declining cigarette consumption; down-trading and competition, including illicit products; shifting consumer preferences; supply or facility disruptions; and grape-supply, regulatory and competitive risks in wine. Management stated that it could not estimate a loss range for many pending tobacco cases and had not accrued for those matters because losses were not considered probable and estimable.
  • Litigation and contingencies: PM USA had approximately 3,200 state-court and 1,200 federal-court Engle progeny cases pending at year-end, based on company estimates. Management warned that an adverse outcome could materially affect results, cash flows or financial position in a particular period. Other notable exposures include class actions, the U.S. government RICO judgment requiring non-monetary remedies including corrective statements, and challenges to state bond caps. A $27 million amount was posted as security for certain judgments under appeal.
  • Other items: No goodwill or indefinite-lived intangible impairment was recorded in 2013, but the fair value of cigar trademarks exceeded carrying value by only about 18%. The company reported approximately $5.174 billion of goodwill and $12.058 billion of net intangible assets. The 2013 pension funded deficit improved to $60 million from $1.757 billion, largely reflecting actuarial gains and investment returns; management anticipated lower 2014 pension and postretirement expense.

Important facts for investors to verify

  • How much of 2013 earnings growth reflects recurring pricing, volume and cost performance versus the $664 million NPM Adjustment benefit and other special items.
  • Whether the 2014 EPS guidance and expected adjusted growth are achieved, including the assumptions behind management’s non-GAAP adjusted EPS measure.
  • Developments in NPM settlement challenges, Engle progeny cases and other tobacco litigation, including potential cash, bonding and non-monetary consequences.
  • The effect of cigarette-volume declines, consumer down-trading, smokeless-category competition and execution of e-vapor expansion on segment margins and market share.
  • Debt maturities, financing costs, working-capital needs and capacity to sustain dividends and repurchases while meeting settlement and regulatory payments.
  • Potential impairment sensitivity for cigar trademarks and other significant intangible assets, and the realization of pension and tax assumptions.