Why Is Our Price Estimate For Altria Over 10% Higher Than The Market Price?

Altria (NYSE:MO) has had a strong performance this year, despite increasing pressures as a result of a decline in the smoking rates in the US, which has witnessed one of the steepest falls in the smoking prevalence in the world. The smoking rate has come down from 21% in 2005, to under 17% today, and is estimated to decline at a rate of 3% per annum till 2040. This has been a consequence of the numerous tax hikes, ban on tobacco marketing and smoking in public places, and growing awareness among the consumers. In spite of this, Altria, in the third quarter (ended September) delivered an excellent performance, on the back of strong income growth in the core tobacco business. Marlboro maintained its retail share near record levels, while Copenhagen, a key brand in the smokeless products segment, delivered a convincing volume and retail share growth. In the quarter, the company strengthened its balance sheet as well, by tendering for high coupon debt and refinancing it with lower coupon, longer maturity debt. Here we’ll list out some of the reasons why our price estimate is close to 11% higher than the current market price.

See Our Complete Analysis For Altria

1. The iQOS Opportunity

The new smoking technology developed by Philip Morris, which heats tobacco, instead of burning it, can be a game changer for the industry. The company has spent over $2 billion on R&D for developing products as an alternative to cigarettes. Altria has a partnership with Philip Morris, and hence, will get exclusive rights to sell the iQOS system in the US. The prospects of this technology look very bright, as evidenced by the recent third quarter earnings results of Philip Morris. Japan is the only country where the national roll-out of iQOS has occurred, and it has witnessed exceptional performance. The market share has steadily climbed since it was first introduced in the country. During FY 2015, the iQOS launch was expanded in Japan to reach 60% of the adult smoking population, and the national roll-out was completed in the beginning of the second quarter. For the third quarter, the HeatSticks market share increased to 3.5%, an increase of 1.3 points, compared to the second quarter. Furthermore, the share in the last week of September, it reached an estimated 4.3%, and an even higher 7.3% in Tokyo, despite limited expansion due to supply constraints.

2. Stake In SABMiller

Altria has an approximately a 27% economic interest in SABMiller, which allows it to participate in the ~$36 billion global profit pool. Equity earnings from this stake have grown from $600 million in 2010, to a little over $1 billion in 2015, a compound annual growth rate of 10.9%. Altria will also benefit from the completion of the merger between SABMiller and Anheuser-Busch InBev. MO will attain a sizable one-time gain of $4.55 per share, which will be reflected in the first quarter of 2017. This enables the company to benefit from diverse income streams. The two beer companies are highly exposed to the fast growing markets of Africa, Latin America, and Asia, resulting in higher earnings and dividend growth prospects. For example, SABMiller has a 34% market share in the African continent, where sales are expected to witness a growth of 44% between 2014 and 2025, three times the expected global growth rate. Such factors will indirectly benefit Altria, due to its stake in the business.

3. Dominant Position In the US

Altria’s Marlboro brand is the number one brand in the US, and has a 44% share in the country’s tobacco market. The addictive nature of cigarettes not only builds a high level of brand loyalty among customers, but it also makes the products less price elastic. Given the massive share that Altria has in the market, its Marlboro cigarettes can be considered even less vulnerable to price hikes. This ensures that the revenue of the company can continue to increase, despite the declining volume of cigarettes sold.

4. Over-Reaction To The California Tax Hike

California Proposition 56 had sought to raise the cigarette tax by $2 per pack in California, more than tripling the tax from its current level of $0.87. It also aimed to impose similar tax hikes on other tobacco products, as well as electronic cigarettes. The revenue earned from this tax would go primarily into funding healthcare programs, tobacco use prevention and control programs, and tobacco related research. California voters supported this proposition, voting 63% to 37% in its favor. This may be perceived to be bad news for big tobacco companies such as Altria, since the California cigarette market is the second largest in the nation, and constitutes 8% of the US cigarette market. However, in one of our earlier articles, we analyzed the effect this will have on Altria’s revenues, and estimated a negative impact of just a little over 1%. Three other tobacco tax initiatives introduced in other states were defeated, and so this hike in California may be of a one-off nature. Since the cigarette tax hike approval, the shares of Altria have fallen considerably. Considering the relatively small impact on the earnings of the company, the decline in the stock price seems like it may be an over reaction by the market.

Have more questions on Altria? Have a look at the links below:

• How Will The California Cigarette Tax Hike Impact Altria?
• Altria’s Smokeable Products Segment Rebounds From Declines Seen In The Second Quarter
• BAT’s Possible Acquisition Of Reynolds To Shake Up The Tobacco Industry
• Can Marlboro’s Dominant Position Result In Further Growth For Altria?
• FDA Cracks Down On Online Sales Of E-Cigarettes
• Altria Q2 Earnings: Marlboro Volumes Fall, But Overall Market Share Remains Flat
• How Will Altria Perform In Q2 2016?
• Is Altria’s Growth Sustainable?
• What Can Lead To A 10% Downside In Altria’s Valuation In The Next Few Years?
• Which Is A Better Dividend Bet – Altria Or Philip Morris?
• Altria’s Stock Still Smoking Hot After The Brexit
• What Will Be Altria’s Revenue And EBITDA Breakdown In 2016?
• What Are Altria’s Strategies For Long-Term Growth?
• How Will Altria Perform In 2016?
• How Will The New FDA Ruling On E-Cigarettes Help Altria?
• What Is The State Of The Vapor Market In The U.S.?
• How Did The Different Segments Of Altria Perform In Q1 2016?
• Impressive Growth In The Smokeable Products Segment Helps Altria Beat Estimates
• How Will Altria Perform In Q1 2016?
• What Are Altria’s Strengths Driving Long-Term Growth?
• What Are Some Obstacles To Altria’s Long-Term Growth?
• How Will Altria’s Revenue And EBITDA Change In The Next 3 Years?
• How Has Altria’s Revenue And EBITDA Composition Changed In The Last 5 Years?
• Altria: Year 2015 In Review
• How Has Altria’s Shipment Volume, By Brand, Changed Over The Past 3 Years?
• How Has Altria’s Retail Share In Smokable Products And Smokeless Products Changed Over The Last Year?
• What is Altria’s Revenue And EBITDA Breakdown?
• What is Altria’s Fundamental Value Based On Expected 2016 Results?
• By What Percentage Did Altria’s Revenue & EBITDA Grow In The Last 5 Years?

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