Altria Group, Inc. (MO) Q4 2012 Earnings Report, Transcript and Summary

Good day and (inaudible) 2012 Fourth Quarter Earnings Conference Call. Today’s call is scheduled to last about one hour including remarks by Altria’s management and a question-and-answer session. (Operator Instructions) Representatives of the investment community and media on the call will be able to ask questions following the conclusion of the prepared remarks. I would now like to turn the call over to Mr. Brendan McCormick, Vice President, Investor Relations, for Altria Client Services. Please go ahead, sir.

Good morning and thank you for joining our call. I am joined this morning by Marty Barrington, Altria’s Chairman and CEO and Howard Willard, Altria’s Chief Financial Officer. This morning we will only be discussing Altria’s 2012 business results for the fourth quarter and full year and will not be discussing the status of tobacco litigation. Our remarks contain forward-looking and cautionary statements and projections of future results, and I direct your attention to the forward-looking and cautionary statement section at the end of our earnings release for the review of the various factors that could cause actual results to differ materially from projections. For a detailed review of Altria’s business results, please review the earnings release that is available on our website, altria.com. Altria reports its financial results in accordance with U.S. Generally Accepted Accounting Principles. Today’s call will contain various operating results on both a reported and on an adjusted basis, which excludes items that affect the comparability of reported results. Descriptions of these measures and reconciliations are included in today’s earnings press release and are available on our website. In addition, comparisons discussed in this conference call are to the same prior-year period unless otherwise stated. Before we begin I want to make you aware that high winds in the Richmond area have been causing interruptions to our phone service this morning. In the event we get disconnected, we have some backup plans in place and I ask for your patience. If you remain on the line, we will rejoin quickly. Now it gives me great pleasure to introduce Marty Barrington.

Thanks Brendan. Good morning everyone. Altria delivered strong results and returns for its shareholders in 2012. Altria grew its full-year adjusted diluted earnings per share by 7.8% behind the business performance of our operating companies, complemented by higher earnings from our equity investment in SABMiller. Our 2012 total shareholder return of 11.8% for the full year outperformed our U.S. tobacco peers and the S&P 500’s consumer staples sector, though not the S&P 500 index which delivered a total return of 16%. Altria’s results were driven by effectively executing on our core strategies. First, our consumer products companies invested in strong premium brands that provide the foundation for future income growth. Each of our tobacco operating companies seek to grow income while maintaining modest share momentum for its core premium brands. Despite a continuing challenging external environment, our tobacco operating companies’ premium brands had an excellent year as our companies continued investing for their long-term success. These companies grew their adjusted operating companies’ income and gained retail share in cigarettes, cigars and smokeless tobacco for the full year of 2012. Beginning with the smokeable product segment, PM USA introduced Marlboro’s new brand architecture in 2012 and supported Marlboro’s four product families, red, gold, green and black with brand building activities throughout the year. These activities included expanded distribution of products and equity enhancing promotions to engage millions of adult smokers. PM USA also engaged adult competitive smokers with trial generating promotions as PM USA moderated as the year progressed. Behind these investments PM USA grew Marlboro retail share and strengthened the Marlboro brand. Middleton continued to enhance its product portfolio and new products contributed to its full year retail share gains. In smokeless product segment, Copenhagen and Skoal delivered solid volume growth and retail share gains on a combined basis for…

Thank you, Marty. Good morning everyone. The smokeable products segment’s reported operating companies income results for the fourth quarter increased 25.9% primarily due to higher list prices, lower restructuring charges and lower charges related to tobacco and health judgements partially offset by higher promotional investments by PM USA behind Marlboro’s new brand architecture and increased resolution expense. For the full year of 2012 reported operating companies’ income for the segment increased 8.8% primarily due to higher list prices, lower restructuring charges, lower charges related to tobacco and health judgements and effective cost management, partially offset by higher promotional investments, increased resolution expense, unfavourable mix due to L&M’s volume growth and lower shipment volume. Adjusted operating companies’ income, which is calculated excluding restructuring charges and tobacco and health judgments, increased 5.9% to $1.5 billion for the fourth quarter and 4.2% to $6.3 billion in the full year of 2012. For the fourth quarter and full year, adjusted operating companies’ income margins for the smokeable product segment increased nine-tenths of a percentage point to 39.9% to 41.2% respectively. PM USA’s reported cigarette shipment volume increased 0.4% for the fourth quarter primarily due to retail share gains and one extra shipping day, partially offset by the industry’s rate of decline. After adjusting for the extra shipping day and changes in trade inventories, PM USA’s fourth quarter domestics cigarette volume was estimated to be down approximately 1%. For the full year PM USA’s reported shipment volume decreased 0.2% primarily due to the industry’s rate of decline, partially offset by volume growth as a result of retail share gains and one extra shipping day. When adjusted for an extra shipping day and changes in trade inventories, PM USA estimates that its full-year domestic shipment volume was essentially unchanged, outperforming the estimated adjusted industry rate of…

Thank you. (Operator Instructions) Our first question comes from line Nik Modi with UBS.

Yeah. Good morning, everyone.

Good morning, Nik.

So just a quick question on the Marlboro architecture, and I guess, now that’s been kind of in place for a year and you saw some pretty good retail share gains with pricing improvement. Just curious are there any diagnostics that you have, that you can share, kind of giving us some insight on how effective this has been and so we can think about next year and the years after in terms of some of the benefits you will get from this initiative.

Thanks for your question. Sure we have diagnostics, some of which are internal and some of which we talk about in settings like this, I think you’ve already alluded to one, which is we had nice share gain which is consistent with PM USA’s objective to maximize income but trying to keep Marlboro healthy. We have diagnostic, Nik, on resetting retail. One of our objectives during the year was to try to get a number of retail stores reset to better reflect the Marlboro architecture, and I think our sales and distribution group did an excellent job of doing that. If you have been in stores I think you have seen the improvements that have been made at the presentation of the Marlboro brand at retail. At the end of the day, it’s always about that balance about trying to maximize income while taking the steps that are appropriate to make sure that Marlboro is healthy over the long term, and we’re very pleased with how PM USA executed on that this year.

And Marty, just a quick follow up to that. I don’t think I remember two quarters in a row where Marlboro has gained this much market share which is quite a feat given how big the brand is and it’s philosophical, I mean you say you want to maintain market share momentum and optimize income. It would be crazy for me to think that this is just too much share gains for a brand that size.

I think Nik, the difference simply is in what time period you are looking at. If you look at it, say for a quarter or even for two quarters you have to be sure that there were some share gains there, but that is not the strategy. I’d just give you a – for example, just one data point because we manage the brand over time, and when we say over time we’re talking about more than several quarters, in fact over years. And if one looks back, pick the data point, fourth quarter of 2009 and you measure share gains to the fourth quarter of 2012, it’s nine-tenths. So you have nine-tenths of share point over three years. We would characterized that as modest share momentum for Marlboro over time, and of course, we have other metrics to measure Marlboro’s health. We want to make sure that all of its brand equity numbers are strong and hopefully improving in the right direction. Nik, I think that’s how we think about it. And we try to be sure -- share gains are not just a function of how much we invest into brand but other competitive dynamics. And so it’s awfully, awfully hard to read simply on a quarter or over two quarters. So I would return I think to understanding our strategy. Our strategy is to maximize income there.

Your next question comes from the line of David Adelman with Morgan Stanley.

Just a follow up on pricing, Marty, if I could. So in 2012 relative to the last few years, there was clearly a greater emphasis on investing in Marlboro promotional spending, somewhat less than that pricing, and very good share growth. Can you give us a sense what’s in the plan for 2013 in terms of the relative emphasis of those variables?

Now I think we will continue with our strategy, David and obviously for competitive reasons we’re not going to lay out PM USA’s promotional plan for 2013. But I do think at a strategic level, it's important for investors to remember our strategy is to maximize income. You’ve seen the numbers in the release. In the smokeable segment we’ve got revenue net of excise up 3.6% for the fourth quarter, and overall the Marlboro brand is heading in the right direction. We have the Marlboro architecture started but remember big brands like Marlboro we don’t do everything in one-year. We've been clear I think about saying that we’re going to invest in Marlboro appropriately throughout 2012 and 2013. But I think that's just more of executing against that consistent strategy and some years as we say we invest a bit more, some years a bit less, some years the shares go up a bit more, it comes down a little bit. But it’s consistent with that long term strategy of trying to maximize income. I think that’s the way to understand it.

Marty, with respect to the total U.S. cigarette category dynamic, you mentioned volumes for the full year or consumption got about 3% with almost no net price increase to consumer. Is that the kind of secular volume decline you would have expected and that you envision going forward?

Well, I don’t know about going forward, because it’s awfully hard to predict the future. But I think that we’ve seen the estimates of the secular decline rate being in the neighborhood of 2% to 3% for some period now, and that’s probably in the right neighborhood.

And then lastly Marty, you would be surprised if the FDA doesn't release its report on menthol by when.

I’d try not to be surprised by regulatory action. I just don’t think we now – I mean they have had it for some time as you know and our understanding remains I think the last time we spoke about this which is they have sent it out for period review on the science. We led to understand that they probably have it back and are looking at it, and we would expect that would be the first action that they would take would be to publish their position on the science on menthol. As you know they have had it for quite some time. So would you expect something in 2013? I suppose so, we just don't have a lot of line of sight into that.

Your next question comes from the line of Michael Lavery with CLSA.

Just looking at the CapEx, your guidance is sort of roughly flat to up for ’13 and it looks like this ’12 was ahead of last year as well. What’s driving some of that increase?

This is Howard. I don’t think there is any single big item. As you will note, our CapEx runs at a relatively low level for a company our size. I think that’s driven by the declining cigarette business. But our direction to our operating companies is they ought to spend the appropriate amount of money to keep the infrastructure appropriately ready to manufacture our products and execute our programs. So I think it really is more driven by the addition of a number of relatively modest sized projects across the business.

And then just as you look at e-cigarette segment, it’s clearly got some strong growth at least in recent times especially, how do you view that, is it an opportunity to get involved in, a threat, something that you sort of dismiss, what’s your thinking? I mean obviously haven’t heard any announcement yet but do you have plans to participate in that somehow?

Well, what I would say about e-cigarettes, Michael, is that we’re monitoring it carefully. It’s obviously a development that has resulted in high awareness among adult smokers and everyone else the best I can tell. There is some trial but it’s still a relatively new phenomenon, and you are right to point out that it does grow off of a relatively low base. The FDA has said as you know that it intends to regulate e-cigarettes. So we’re monitoring all of that very carefully.

And then lastly, just looking at share repurchases, you mentioned that you had $57 million remaining in this authorization. But you’ve said you would expect to complete that by the end of 2Q which would be a sharp slowdown, you did $360 million in 1H ’12. If you use that how quickly could you get a new authorization or do you think it will run its latest 2Q before you have another one?

Yeah. I think it’s hard to project exactly when we will finish that authorization but certainly we will have it complete by the end of the second quarter. I think you pointed out I think rightly so that we had fairly heavy purchases in the fourth quarter and we’re only $57 million left. There is not a lot of share repurchase needed to complete that. But at this point, the only authorization that we have out is that authorization is scheduled at the end of the second quarter.

Okay. Thanks a lot.

Thanks for coming on the call, Michael.

Your next question comes from the line of Judy Hong with Goldman Sachs.

Thanks. Good morning, everyone.

Good morning, Judy.

Marty, just a general kind of a macro comment, I know, in the press release you’ve talked about and then also in your prepared comment some of the cautions that you pointed to at the expiration of the tax holiday et cetera. I know you sort of start the year with the similar caution in the past but is there anything that you’re seeing in the market place that gives you a bit more caution at this point, particularly with the tax holiday being expired.

No. We haven’t seen any evidence of that but we’re just -- we're reminded almost everyday right about how complex the macro environment is. It looks like on some days the things are starting to turn in the right direction, say housing starts through the like, which is important. And then you get a big drop in consumer confidence or you see a kind of a tepid prediction on GDP. I think that's part of it. I think the other part of it is excise taxes. We’re always careful at the beginning of the year with respect to state excise taxes, state budgets remain in difficult circumstances. Nothing’s happened yet but you’ve seen already a number of states proposing -- and proposing is one thing and getting them is another but they’re proposing fairly significant excise tax increases. And given that the FETs have been relatively restrained the last couple of years. We would expect that there would be an uptick in activity there. So to answer your question directly is not that we see anything in the market that gives us that any cause for alarm. We’re just trying to be careful as we read the macro environment.

Okay. That’s fair. And then just going back to the Marlboro brand architecture, so heading into sort of the second year of that program. Can you elaborate on sort of your success with some of the line expansions, certainly the Black and then now with NXT. How are each of those brands kind of tracking versus your expectation. What is some of the other innovations of line expansion that we should look forward to in 2013 and then just in terms of the level of investment behind the brand equity program as well as some of the retail program. How do you sort of gauge whether the spending level is sort of at the right level if there is a need to continue to step up that spending?

Okay. There is a lot in your question there. Let me see if I could take sort of pieces of it at a time. If you look back at ‘12 at the accomplishments of the Marlboro architecture, I think they are actually quite significant and we pointed out that when we talk about building up the Marlboro architecture, it consists of multiple elements, right. It's focusing on all of the elements of the value equation that we used to manage that terrific brand. So what have we done in packaging, you see what we’ve done with Marlboro 83s which is really a nice expansion into some more modern and classic packaging for that brand to bring news to Red. So our product expansions in Marlboro-Black which has been a terrific contribution to the family while we don't report out at this sub-segment level on growth. As you know, I can tell you that we’re very pleased with how Marlboro-Black has done. And it certainly contributed, I think to the overall Marlboro equity. But we saw Marlboro NXT, you see all this innovation in Marlboro space and that's good for the brand. And we think of building up the Marlboro architecture sort of less as a program, if you will then, what good stewards of tradition -- of wonderful brands like Marlboro are supposed to do that. They manage the brand over time. They keep it refresh, they keep it relevant to its target audience and that's how we've been working on it. So you see, I’ve already mentioned retail, you see product introductions, you see packaging changes. I think that's the way to try to understand how we’re thinking about Marlboro. It's a big brand. It has a big franchise and our four product families, I think, are working hard to try to understand their consumer set carefully and bring to the market, what that consumer wants. So we don’t announce in advance, when we’re ready to announce what we’re going to do in 2013. But you're probably aware of Southern Cut, which has been launched already in January. So there's a lot of innovation in Marlboro but we do this in a discipline way because all of that, that I have described sits under the strategy of trying to maximize income in that segment. We’ll make true that the brand does well. So it’s a balance. That’s why we get paid to balance and that’s what we’re trying to do throughout 2013. But I think that PM USA did an excellent job of that in 2012 as you see in the results.

Okay. Thank you.

Thanks for the question.

Your next question comes from the line of Bonnie Herzog with Wells Fargo.

Good morning.

Hi Bonnie.

Hi. I guess, my first question is on retails and what are your thoughts on retailer cigarette margins being squeezed over the past year. How do you strike the right balance between growing your own profitability and then maintaining a mutually beneficial relationship with your retail partners? And also how do you ensure that retailers continue to emphasize important cigarette category and prevent them from shifting resources to other categories either within tobacco or other categories outside of tobacco maybe such as food service.

Okay. Well, thanks for that question. Our approach to retail has really been the same for some time which is we want to have a terrific relationship that’s mutually beneficial for both us and them. We work really hard at multiple levels to do that and we do that programmatically. And so you see that we have programs like MLP in Marlboro [Flakes] and the like. And we try to have a range of options so retailers can decide which programs if any they want to participate in with us. We try to make it attractive for them to do so. Retailers for their part, of course, the cigarette and the tobacco categories a big part of their traffic, a big part of their revenue stream and we try to work with them very carefully. We do that to our very talented salespeople who had very good market data to help them almost down to a store basis but our job isn’t to tell them what to do or to prevent them from doing something else, just to try to align their interests with ours. So that as we go to market that's a robust trade channel. I think overall -- overall I think our retailers would tell you we do, I think, a pretty good job of that and we also meet with retailers regularly, Judy, both at the executive level and all the way down to the store level to get feedback from them about how we’re doing. Our hope is that we’re really the category leader for them in terms of solutions.

Okay. That makes sense. And then I had another question on kind of circling back on some of the earlier questions regarding promotions. And I guess, I’m aware that your promotions on certain line that Marlboro has decreased this month and then in February. So I guess this leads me to believe that volume impact has been minimal on Marlboro. And I just want to make sure this is the right way to think about this and maybe you could touch on other levers you have to pull to improve your net price realization next year. And I definitely would like to clarify or verify that this is in fact a priority for you in 2013.

Well, I think I would say what I’ve said before on this topic, which is when you're trying to maximize income there are a number of ways one can do that. Certainly, pricing has been important in the category. It has been, it’s likely to be. It’s certainly something we look at very carefully. You saw PM USA took two price increases last year. You’ve already pointed out that you’ve seen some of the promotions moderate over time. So PM USA is very attentive to keeping an eye on the pricing element, but it's not the only one. You can expand your margins as you’ve seen them expand through effective cost management and Howard’s already described where we are in our current cost programs. We try to be efficient in going to the market. So we keep a good eye there, we have very good margins there. We’ve expanded them throughout 2012, and we’re mindful of that as we head into 2013.

And then just my final question is on innovation in your portfolio and understanding your strategy regarding innovation and in light of the lack of progress with substantially equivalent application approvals. So I guess I would like to know if your innovation will be as robust as last year, if approvals don’t happen for a while and maybe you could update us on the status of that please.

Sure. Well we continue to engage with the agency on our substantial equivalence application and I think we have good dialogue with them back and forth as they work through that. You probably know Bonnie, there is something in the order of 4000 applications that came in March two years ago but they are coming up on the two-year anniversary of that batch of filings. And so I think you expect for them to start working through those at some point in time. With respect to our pipeline, we were pretty thoughtful I think about trying to get ready for the new regulatory environment, and you saw actually in 2012 that we've been able to keep a pretty robust pipeline of products and other offerings to our consumers. We do that in compliance with all the rules that are in place. We would expect to continue to do that. So it’s awfully hard to predict right because we don't see into the agency, I know you don't and I don't. But I would expect for them to start moving things along.

Your next question comes from the line of Priya Ohri-Gupta with Barclays.

Can you share your view around the potential for additional liability management, exercises, perhaps targeting your longer dated maturities that didn’t get tackled the last time? And then secondly, how do you think about the timing of prefinancing your upcoming maturities given the current market backdrop?

Sure, this is Howard. I think as everybody is aware, we did do a tender for some debt last year and one of the drivers of that was we were mindful of the fact that we had some high maturity towers in 2018 and 2019. Additionally it provided us with some ongoing interest savings when we reissued debt at a lower interest rate. I think we’re pretty comfortable with our maturity towers right now. And I think as we look at both the debt issuance and any kind of tender or refinancing activity, I think we look at it in the context of a much broader analysis, how to effectively use our cash. And I think as you know 80% of our underlying EPS go out in the form of dividends, and then each year I think we make a decision as to what the most effective use of that remaining cash is, and I think we are going to remain flexible as to how we use that cash going forward.

And then any comments on how you think the runway ahead of the maturity if you are thinking about refinancings you like to have three to six months cushion, or sequentially even do something afterwards given the flexibility from commercial paper uses?

Yeah obviously, when we are looking at issuing debt, we do quite a detailed analysis. I don’t know that we have kind of a hard and fast rule like you may be suggesting there, but it’s something we analyze quite carefully.

Your next question comes from the line of Vivien Azer with Citi. Vivien Azer – Citigroup: I was hoping that we could talk a little bit more about Marlboro and specifically on the share gains that you posted, if you could give any color on the contribution from new product introductions to the share gains that you have seen in 2012 as well, if you could offer some color on some of the consumer demographics as you have done the work on that, are you gaining outside share with smokers of 18 to 30 or anything like that?

We do look at those, of course, but those are competitively sensitive details that we don’t discuss in these kinds of settings. But I can tell you Vivien, overall we’re really happy with those product introductions and what they brought to the brand. They brought innovation to the brand, they brought great packaging to the brand. We like the contribution that they're making to the overall equity of the brand. And as you might expect our brand teams monitor all of that activity carefully, and I think overall we’re very pleased with that. We just don’t break it out at this level for these purposes, I am sorry. Vivien Azer – Citigroup: That’s fair. In terms of your guidance for 2013, you’re coming off of a big year in terms of the contribution that you got from SABMiller, certainly that’s really been a good contributor to your earnings growth. I was wondering if you could give us a sense of what your expectations are and how you are thinking about the balance between other non-operating items like that and then your reported operating income growth for your segment?

Well, I will start and Howard may want to say a word on this. We always start with the operating performance of our companies. This is as you heard in my remarks that, that's why we were able to grow the way we were in 2012 which was our operating companies had terrific business performance. And so we always start with that and they have robust plans for ’13. And now that said, we do have other levers that we can use to try to balance the overall equation but I think it’s important to understand that we always start with the operating performance of our tobacco companies and our wine companies because that’s the core of our business. Howard, do you want to say more on that?

Sure, I would just add – the comment on SABMiller, I think you pointed out why we saw that SABMiller’s had a strong performance last year and has had quite a run of strong performances over the years. And so when we put together our guidance we certainly factored in an estimate for SABMiller and we have a fair amount of insight into that because of our broad participation. But certainly we have a much deeper assessment of the operating plans for the businesses that we operate. But we continue to expect SABMiller to be a nice contributor going forward.

Your next question comes from the line of Ann Gurkin with Davenport.

I don’t know if you’d comment on the elasticity model and how it has performed or how it compares to historical measures following the price increase taken in December. And I guess elasticity for the premium segments, the Marlboro brand architecture buildouts and the discount segments, can you comment at all on that?

Well, I can comment generally on elasticity and over time it hasn’t changed very much with respect to cigarettes, negative 0.3, we’ve seen that really for quite some time now and we don’t see any change in that. We haven’t seen any change actually in a while, we certainly don’t see any change in it now.

And then just want to be clear, as you think about the Marlboro franchise and your MST business, are there still white bakers (ph) opportunities whether it’s packaging or blends or mixes, to roll out new products, just in general, not specifics.

That’s what the brand teams are doing every day. They are trying to study their consumer set, trying to figure out where there is opportunity and try to develop products for adult customers that we could take to them, sure.

Okay. Thank you.

Thanks for calling.

Your next question comes from the line of Chris Ferrara with Bank of America.

Hey, thanks. Guys, sorry for the basic question of advance. But I guess following up on the elasticity question, can you just talk about I guess, how you gagged the long-term capacity of U.S. consumer due to endure higher cigarette prices? I hear you that the point there hasn’t changed in a while, but I mean surely you guys must spent some time thinking about at what price levels that might change, right. So, I’m just curios how you sort of think about that framework?

I think it’s -- I don’t know how to predict that in the future other than to be informed by what we've seen in the past. There has been a lot of history with respect to, what the prices have been in the industry over time. And that elasticity has remained pretty durable. I guess another way of looking at it, Chris, is that if you look at the pricing in the U.S. domestic markets, the other markets of course you would see that it probably has a pretty long runway in front of it. But nobody knows that I think until you get there and we are not there yet.

And I guess just bringing it more to the short-term, I mean do you guys think that at current levels you could sort of maintain or drive modest share momentum without pricing below the industry average in the cigarette category?

Well, I’ll go back to the comments I made before, which is, it is always tempting I think to kind of break these things out into single constituent elements and it just doesn't work that way. There's always the dynamic between wanting to increase income, which is what our strategy is while trying to maintain share. And that's the balance that you have to assess based on a lot of factors at any one point in time. It depends on what the economy is doing. It depends on consumer confidence. It depends on other factors that we pointed out I think previously. So the way we think about it is, we try to be thoughtful about that, as we run our business each year and we pay close attention to it, but to make a general statement about that is awfully hard to do.

Thank you.

Thanks for calling.

Your final question comes from the line of Chris Burritt with Bloomberg News.

Hey, thank you for your time.

Good morning.

I was going to ask, the release mentions a headcount reduction and was wondering if you could discuss the number of jobs cut last year and whether there maybe further cuts this year?

Well, I can certainly talk about the program that we had in place which was, I think we all described it if I’m not mistaken. I think the results are in our public filings. We have to watch our headcount like every business does, but particularly in our category because cigarette volumes declined. We prefer to manage that over time and we work really hard to do that over time by maintaining our headcount through attrition if at all possible. There have been programs in the past. No one can, never say that there won’t be one in the future. But that’s not our current intention. We are trying to manage our headcount over time, and we hope that we are going to be able to do that.

Thank you. At this time, I would like to turn the call back over to Mr. Brendan McCormick for closing comments.

Thank you everyone for joining our call this morning. We appreciate your interest in Altria. If you have any follow-up questions, please contact us on Investor Relations.

Thank you. This does conclude today's conference call. You may now disconnect.