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Will Altria Successfully Address Stagnating Market Share? – Altria Group, Inc. (NYSE:MO)

Wealth Insights

US tobacco firm Altria Group (MO) has been within the information just lately with a number of stories of varied merger and acquisition talks. The corporate seems to be addressing a troubling development that has seen its Marlboro market share stagnate over the previous handful of years. The corporate’s flagship model had been gobbling up market share for years, which has helped offset macro-degree tendencies of declining cigarette use. With this market share progress reversing, the corporate is being professional-lively in diversifying its enterprise to attempt for long run progress. Whereas there are causes to get enthusiastic about future prospects, buyers ought to pump the breaks a bit. There are some issues that buyers ought to be mindful as these ventures play out additional.

Smoking Is Declining In America

The idea of fewer People smoking cigarettes is nothing new. A declining smoking fee has been a recognized development for years. This doesn’t suggest that smoking is lifeless nevertheless. In line with the CDC, there are nonetheless roughly 38 million People that smoke cigarettes.

supply: Gallup

In recent times this development has accelerated for a few causes. Years of anti-smoking propaganda mixed with options to smoking comparable to vaporizers and digital cigarettes have lowered the “start up rate”. In different phrases, individuals aren’t essentially quitting – merely people who smoke are dying quicker than new people who smoke are choosing up the behavior.

Altria Has Thrived Regardless of This

Altria has countered this development for years in two methods. First, the addictive nature of tobacco provides Altria the power to persistently increase costs with out struggling a lot pushback from clients. Individuals are merely going to discover a approach to fund their smoking behavior.

Internet Worth of Marlboro Cigarettes as of third Quarter Per Pack (by Fiscal Yr)

2015 $6.16
2016 $6.28
2017 $6.64
2018 $6.79

Second, the corporate has carried out a masterful job of gaining market share through the years. Despite the fact that the general demographic of people who smoke has shrunk, Altria has managed to thrive as a result of it has been capable of seize a much bigger slice of the demographic to counter this shrinkage.

supply: Enterprise Insider

The difficulty has turn into the sustainability of this sample. Since hitting retail share of 43.eight% in 2014, market share progress of the Marlboro model has stagnated. Share has drifted barely decrease to 43.four% in September of final yr, and this previous quarter (Q3 FY18) confirmed market share of 43.1%.

supply: Altria Group

That is vital as a result of the Marlboro model is the first income driver for the corporate. Regardless of Altria’s different companies and funding pursuits, cigarettes nonetheless account for 86% of working revenue. Of this phase, about 86% of Altria’s complete cargo volumes are of Marlboro model cigarettes. As Marlboro goes, Altria’s earnings transfer with it. If it wasn’t for Altria receiving an enormous increase from the tax reform legal guidelines, this is able to in all probability be extra mentioned than it’s.

Addressing The Situation

Huge tobacco administration is regarded within the funding group as a number of the brightest minds in company administration. These details are clearly not misplaced on them. That’s the reason it’s encouraging to see the corporate making strikes to deal with it in a significant means. Altria has made it recognized that the corporate is trying to prolong its attain into different industries in an effort to diversify its enterprise with synergistic pursuits.

Altria has just lately been linked to 2 totally different industries in these efforts. A few week in the past, the Wall Road Journal reported that Altria was wanting into a big (but non-controlling) stake in Juul Labs. Juul Labs manufactures the primary promoting digital cigarette within the US. Juul merchandise have come beneath scrutiny from regulators due to how well-liked they’ve grow to be with youthful demographics, particularly youngsters.

This curiosity is sensible for a few causes. Juul’s reputation with youth is an apparent attractor for Altria, whose cigarettes are dropping mindshare amongst youngsters. Juul might stand to profit from Altria’s “expertise” in navigating regulatory hurdles.

Along with digital cigarettes, Altria has begun to formally discover the hashish market. This has lengthy been speculated, as the wedding between tobacco and hashish appears apparent for logistic and synergy causes. The opposite day, a report got here out that Altria has begun early discussions to accumulate Canada based mostly Cronos Group (CRON). Cronos Group has since confirmed these talks. Every of those situations is sensible for Altria given the enterprise fashions concerned, and their similarities to tobacco.

Pumping The Breaks

Earlier than Altria shareholders pop the champagne, nevertheless, there are some key issues to remember relating to every potential deal. There are a number of shifting elements inside each the hashish and digital cigarette business, so Altria wants to remain disciplined and never do one thing “silly” with its money.

Juul Labs is estimated to have annual gross sales of roughly $1.eight billion, and the corporate raised capital at a $15 billion valuation earlier this yr. A “significant” curiosity probably means a hefty price ticket of a number of billion dollars. Juul is quickly rising because the runaway chief of market share within the e-cig market, so a big premium will probably be paid.

supply: CNBC

The corporate has the monetary chops to afford such a cope with $2.39 billion in money, however loads of room on the stability sheet. Altria’s leverage ratio of 1.4X EBITDA is properly underneath the two.5X ratio that I exploit as my “warning sign” threshold. As well as, Altria is a money stream machine with very excessive margins. The corporate turns each gross sales greenback into $zero.18 of free money move. The dividend makes use of solely 72% of those money flows, so there can be funds out there to pay down debt over time. Nonetheless, Altria needs to be cautious to not drastically overpay to the purpose that the debt overshadows the advantages Juul would convey to Altria’s financials.

supply: Ycharts

When wanting on the hashish business, there’s danger in that the business is far much less confirmed out in comparison with Juul. Due to the expansion prospects of the business, there are a handful of smaller gamers buying and selling at hefty premiums. Taking a look at Cronos Group, the corporate has carried out solely about $9 million in revenues over the TTM interval, but instructions a $1.eight billion market cap.

Not solely does this set Altria as much as overpay for Cronos (given what little the enterprise will impression Altria’s backside line), however the firm is presently investing into its capability to develop extra hashish, which means Altria might have to spend CAPEX to proceed rising Cronos publish acquisition.

All of those shifting elements equate to execution danger, and this nonetheless does not think about the truth that hashish continues to be unlawful on the Federal degree within the US. With Cronos being a Canadian firm, this acquisition would clearly be an experiment/gateway into an American enterprise into hashish down the street (when it inevitably turns into authorized). Once you add all of this collectively, it turns into evident that hashish continues to be years away from being a big revenue middle for Altria.

Are Shares A Purchase As we speak?

With shares at simply over $55 per share, Altria inventory is on the low finish of its 52 week vary. The corporate will make nearly $four per share for the complete fiscal yr, putting Altria at an earnings a number of of 13.75X. That is proper in keeping with Altria’s 10 yr median a number of of 14X.

To realize further perspective on Altria’s valuation, we’ll evaluation the free money movement yield. Money move is an natural measure of an organization’s efficiency, so it makes for an ideal valuation software. The additional cash we will obtain per greenback invested, the stronger the return on our funding we stand to generate.

supply: Ycharts

With a free money move yield of 6.86%, the inventory is yielding probably the most money circulate it has because the recession. With an earnings a number of in keeping with historic norms and a strong FCF yield, share of Altria are attractively priced at present buying and selling ranges. Analyst consensus estimates that Altria will develop earnings at a CAGR of slightly below 10% over the subsequent 5 years. With a 5.74% yield from the dividend mixed with a horny valuation, complete returns are poised to surpass the market over the subsequent 5 years.

Wrapping Up

Altria is a incredible firm that has managed to thrive regardless of robust macro-degree headwinds as fewer adults smoke within the US. It is encouraging to see that Altria is being proactive in exploring income diversification whereas the core enterprise continues to be robust. Nevertheless buyers can’t give Altria a blind move on tips on how to undertake this process.

Each the Juul and Cronos Group offers (ought to they occur) would current dangers in their very own proper to what’s at present an asset mild, excessive margin enterprise in Altria. No matter how these situations play out, time shall be wanted to really alter Altria’s income make-up. As this performs out, buyers can presently reap the benefits of a robust money movement producing inventory with a excessive yielding dividend, and a horny price ticket.

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Writer Disclaimer: Wealth Insights is an investor and funding writer. His content material isn’t geared to anybody’s particular funding objectives, time horizons, or danger tolerance. Content material is for illustrative functions solely and isn’t meant to displace recommendation from a charge-based mostly monetary adviser. Accuracy of knowledge isn’t assured.

Disclosure: I/we’ve got no positions in any shares talked about, and no plans to provoke any positions inside the subsequent 72 hours.

I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (aside from from In search of Alpha). I’ve no enterprise relationship with any firm whose inventory is talked about on this article.

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