Altria Group, Inc. (MO) Q2 2013 Earnings Report, Transcript and Summary

Good day, and welcome to the Altria Group 2013 Second Quarter Earnings Conference Call. Today’s call is scheduled to last about 1 hour, including remarks by Altria’s Management and a question-and-answer session. (Operator Instructions) I’d now like to turn the call over to Mr. Michael Neese, Director of Investor Relations for Altria Client Services. Please go ahead, sir.

Thank you, Jackie. Good morning and thank you for joining our call. I’m joined this morning by Marty Barrington, Altria’s Chairman and CEO; and Howard Willard, Altria’s Chief Financial Officer. This morning, we’ll only be discussing Altria’s 2013 business results for the second quarter and first six months, 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 statements 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 at altria.com. Altria reports its financial results in accordance with U.S. GAAP. Today’s call will contain various operating results on both a reported and adjusted basis, which excludes items that affect the comparability of reported results. Descriptions of these measures and reconciliations are included in today’s earnings 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. Now I’ll turn the call over to Marty.

Thanks, Mike, and good morning, everyone. Altria delivered solid financial results for the second quarter and for six months of 2013. The Company’s diverse business model delivered adjusted diluted earnings per share growth of 5.1% for the second quarter and 7.4% for the first half of the year. All three of our reportable segments delivered adjusted operating companies income and margin growth in the second quarter and first half. This growth was complemented by lower interest and other debt expense and fewer shares outstanding for both periods. Lower earnings from Altria’s equity investment and SABMiller negatively impacted Altria’s second quarter adjusted diluted EPS, while on a first half basis higher earnings from the investment had a positive impact. In the smokeable product segment, higher pricing drove adjusted operating companies income growth for both the second quarter and first half. Marlboro continue to perform well. Its retail share was unchanged for the second quarter and up one-tenth of a share point for the first half versus its strong retail share performance last year. PM USA continues to support Marlboro’s brand architecture with brands building initiatives. In July, 2013 PM USA expanded distribution of Marlboro NXT to an additional 23 states, primarily in the eastern U.S. PM USA gain retail share for the second quarter behind share gains for L&M in discount. For the first half PM USA grew retail share due to gains from both L&M and Marlboro. Comparisons of reported cigarette shipment volume for the second quarter and first half were impacted by trade inventory changes. After adjusting for changes in trade inventories PM USA estimates that its second quarter 2013 domestic cigarette shipment volume was down approximately 3.5% and that total cigarette category volume was down approximately 4% for the same period. After adjusting for one less shipping day…

Thank you, Marty. Good morning, everyone. In the smokeable products segment, second quarter and first half reported operating companies income grew by 5.2% and 18.4% respectively, primarily due to PM USA’s settlement with certain states of the NPM Adjustment Disputes for 2003 to 2012. Higher pricing and lower selling, general and administrative expenses partially offset by lower reported shipment volume. Excluding special items identified in our earnings press release, adjusted operating companies income for the smokeable products segment increased by 1.5% to $1.7 billion for the second quarter, an increase by 1.4% to $3.1 billion for the first half. Adjusted operating companies income margin grew 1.6 percentage points to 43.0% for the second quarter and 1.3 percentage points to 42.5% for the first half. PM USA’s reported cigarette shipments declined 6.7% for the second quarter, primarily due to the industry's rate of decline and changes in trade inventories, partially offset by retail share gains. PM USA believes that the trade built more inventory during the second quarter of 2012 which negatively impacted the comparisons of PM USA's second quarter 2013 reported domestic cigarette shipment volume. Reported cigarette shipments declined 6% for the first six months of 2013, primarily due to the same factors that impacted the second quarter and one less shipping day. PM USA increased its retail share by three-tenths of a share point to 50.7% for the second quarter and by four-tenths of a share point to 50.6% for the first half of 2013. Marlboro's retail share for the second quarter was unchanged at 43.7% and grew one-tenth of a share point to 43.6% for the first half. PM USA's discount share was 3.9% for both periods as share gains for L&M contributed to share gains of five-tenths of a share point for both the second quarter and…

Thank you. (Operator Instructions). Investors, analysts and media representatives are now invited to participate in the question-and-answer session. We will take questions from the investment community first. Our first question comes from the line of Vivien Azer with Citi. Please go ahead.

Hi. Good morning.

Good morning.

To start, my first question has to do with the Menthol report that the FDA said that it's the OMB this morning, I'm sure you guys haven't had a chance to go through it neither have we, but I was hoping you could just remind us from a procedural standpoint where do we go from here and what the timing of that would look like?

You're right, Vivien. I heard about the headline when I walked into the room and was focused on the call, so I haven't looked at any of this. So I don’t want to comment on it because I haven't seen it. But you’re right from a process view point what the FDA has said so far all along was that it was reviewing the science. It took the TPSAC report; it conducted its own scientific review. It's our understanding they sent that out for peer review that they got peer review back and then they've been working on the scientific assessment. So subject to what's happened this morning that’s our understanding of the process. And of course FDA being an agency that’s driven by science and the evidence, we would expect for the process then to discuss FDA scientific views before any policy implications or the like would be discussed. We’ll have to see what issued this morning.

Fair enough. In terms of the cigarette business was there a benefit to your shipments from the extended distribution of NXT or is that going to hit in the third quarter?

Well, we launched NXT really in July, so it will be mostly in the third quarter I think.

Fair enough. And do you have an estimate for whether the e-cigarette category had any impact on traditional cigarette industry going this quarter and next so, by what magnitude?

Yeah, no I really don’t – I know everyone is acutely interested in this. I continue to believe what I’ve said previously on this which is, it's having some effect obviously because people who were trying eBay for products are adult smokers, so you would expect for there to be some effect. We just can’t tease out what it is off of the small base, and actually I think the question to be focused on is as much, what is the size of that category today as what might it be down the road and that’s obviously a part of the motivation for us to make sure that we’ve got competitive products and why we’re so excited about our mark and launch in Indiana.

That’s fair enough. And do you have an estimate for what the size of the category might be down the road?

No, we worked out various scenarios. It all depends which put in your model and it depends what your assumptions are. As we’ve discussed previously there is a lot that’s yet to be resolved regarding e-cigarettes. We currently don’t have a regulatory structure for them and depending on what that regulatory structure looks like it could have an impact on the size of the category. We don’t know yet about excise taxes for example. We’re probably on the early part of the technology curve with the product itself. So all of those factors Vivien I think are the way that we’re looking at it and you can run various models with various assumptions, and that’s kind of how we’re looking at it to make sure that we’ve got all of them covered.

Terrific. Thank you.

Thanks for calling in.

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

Good morning, everyone.

Good morning, David.

Marty, just as a follow-up to that, if you have three buckets of uncertainty regarding the trajectory of the e-cigarette category being regulation, excise taxes, and then the capacity to improve the product to meet current smokers needs. Realistically would you agree that it's probably that third item that will have the biggest long-term impact on whether e-cigarettes are sort of a small or somewhat larger segment over time?

I sure think that consumer acceptance of the product is central. The other factors -- and there are other factors beyond what I mentioned, but you’re right David you have to have a product that adult consumers find acceptable and that’s what we’re working on.

Okay, on a different topic, Marty given the gap between your shipments this quarter and where you think on an underlying basis both your performance in the category was the negative 3.5, negative 4. What's your confidence in that forecast, in that assessment?

Yeah, we’re pretty confident in our assessment, I would say. When you look at the inventory changes from Q2, '12 to Q2, '13 I mean they’re pretty apparent, as I know you remember the trade bill inventory in the quarter last year versus this quarter where it was built and then really shared, some of that’s probably driven by the timing. You may remember the price announcements came at different times relative to those quarters. So when we do the math and we look at the inventories that we’re able track we’re pretty confident that it explains the difference between reported and adjusted.

Okay and that would be consistent with your cigarette shipments in July of this year being fairly strong, correct, because you would have entered the quarter with lower trade inventories than last year?

Well, as you know we don’t talk about the quarter until the quarter is over, so I won't say anything about the third quarter. But I do think it's fair to point out as people are thinking about this which is, if the adjustments are as we believe them to be. Remember there’s one more shipping day in the third quarter and inventories really were pretty lean at the end of the second quarter. Those were all factors I think to take into account.

Okay. And then Marty, just fair to say that sort of collectively the competitive dynamic has allowed for better pricing in the cigarette category essentially because of the weaker volumes that the competitive dynamics resulted in a business algorithm that still allowed for profit growth despite the weak volumes because in affect there was a collective effort to solve for weak volumes?

I might describe that just a little bit differently. I think the category is competitive, it's been competitive, it’s likely to be competitive. Our strategy is to maximize income as you know, and so we stay focused on that in this segment. And when we look at our revenue/1000 for example net of FET we’ve got nice numbers there. So that’s how we look at it, which is we’re trying to maximize income while making sure that we’ve got modest share momentum on Marlboro.

Okay. Thank you.

Thanks a lot for calling.

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

Thanks. Good morning everyone.

Good morning, Judy.

I guess, I just wanted to go through the brand performance on the cigarette side, so Marlboro kind of flat year-over-year up a little bit in the six months of the year, and then you actually had a pretty good gain from L&M. So maybe just give us your perspective on the Marlboro’s performance maybe not just in the quarter, but just kind of a year-to-date, how do you think the brand is performing relative to kind of your spending level? And then from an L&M perspective, can you just talk about where the share gains are coming from and as though you think about the strategy with L&M, would we continue to see a pretty strong gain from L&M going forward?

Sure, let me take those in turn. We’re really happy with Marlboro. I think Marlboro is doing terrific. The investments that we’ve made in the Marlboro architecture, the products that we’ve been able to bring, our work at retail to get everything reset, the work that we’ve done on marlboro.com, our interactions with our adjust consumer franchise. Remember we tend to sometimes go pass this, but it's worth everyone remembering of course Marlboro remains with more shares than the next 10 brands combined. It's got premium pricing. It's got the highest brand equity. It's the largest brand in every state and so on and so on and so Marlboro continues to perform fine. As I just discussed with David as you know, in terms of its share we try to have modest share momentum on Marlboro. That’s one of the measures we use to make sure that its brand strength remains where we want it to be because it's largely the engine of our profit growth. L&M’s role is different of course; it plays a role in the discount segment. The discount segment as Howard just reported to you is relatively flat, but especially for some of our trade partners who like for us to have an entry in that segment; L&M is a terrific choice. We gather share from various players that are participating in that segment, but our focus is on premium and in particular it's on Marlboro, but L&M has a role to play in the portfolio about what you’ve seen for the quarter, I think it's fair to say.

Okay. And then just in terms of the competitive environment going forward, just curious with Newport Gold being launched in the back half; do you see that as a risk in terms of the competitive environment heating up, and then just in terms of thinking about broadly speaking, the new product pipeline for your products obviously and how much of that is still kind of dependent upon the FDA coming up with just potential equivalents, applications and any lessons that you’ve learned on the heels of them approving a couple and then also rejecting several?

Okay, let me see if I can unpack that a little bit. Our planning as you might expect at PM USA and other operating companies takes into account most, all competitive scenarios including the one on Newport Gold that you’ve just described. So, we have plans for that and all of that is rolled up into our guidance. So, I think that we have good plans; we have a strong franchise there. PM USA will do what it needs to do I’m sure and do it well. In terms of new product pipeline, we’ve discussed this previously I think with others about how we were pretty planful about having products as the new regulatory system came online and we continue to have a pretty good pipeline. We had also pointed out that we have expected FDA once it had built out its infrastructure, once it had hired its staff and once it had worked through the protocols on substantial equivalents, we had fully expected that it would start to rule on application and indeed that's what we see happening and that's a good thing, frankly. Some people were predicting that the FDA would never approve another tobacco product or certainly not in the cigarette category and we were urging people to be mindful that the statute contemplates innovation in the category, it's just a process you have to go through and FDA is a part of that process. So, I think that's on balance, a good thing that FDA now has the infrastructure up and working. They're working through applications. To be sure, there's a lot to do. I think the latest estimate I saw and you may have seen it is in terms of provisional applications those that are already in the market, there's more than 3,000 of those and then there maybe another 500, I think, FDA said with respect to new products. So they've got some work to do. For our part, we continue to work with them. We talk to them every day about substantial equivalents and other matters and we try to do that professionally and constructively and so far so good.

Okay. And then lastly, Howard, SABMiller equity income was down pretty significantly in the quarter. If there's anything you can help us just kind of think about why it was down so much? And then I guess in terms of your guidance, is it still – I guess it is a driver of how the rest of the year kind of play out. So any help on how we should think about the back half in terms of the equity income?

Sure. Well certainly our guidance reflects what we expect to occur for all of our businesses plus our contribution from SABMiller. SABMiller's contribution to our earnings was often in the first half but you're correct that it was down in the second half on an adjusted basis. I would point out I think that there are a number of adjustments that we make to their financial results both to convert from IFRS to GAAP and some other things. So probably the best way to understand their underlying earnings is to listen in on their trading statement update which will come later this week. But I do think for the rest of the year, we expect SABMiller to be a contributor to our earnings growth.

Got it, thank you.

Thanks for calling, Judy.

Your next question comes from the line of Thilo Wrede with Jefferies. Thilo Wrede - Jefferies & Company, Inc.: Good morning, everybody. Just wanted to follow-up on David's question for the volume adjustments that you laid out because of the inventory movement. If I recall correctly, I think last year same quarter you talked about a 1.5% tailwind. The adjustment you talk about today seems to be much bigger than that. Is there additional volume or inventory reductions by wholesalers on top of just offsetting what they did last year?

I guess I'm not sure how to explain it other than I explained it a moment ago which is it's just the comparison, I think, between the build in the second quarter last year and then the build in the share in the second quarter this year when we looked at the numbers relative to what's in wholesale and our estimate at retail which seems to us that that's the explanation. Thilo Wrede - Jefferies & Company, Inc.: Okay. And then smokeable revenue has been down for two quarters in a row now and the comps in the second half of the year are getting a little bit more challenging, but what's the outlook for the segment? Do you expect growth for the full year?

Well you know our strategy which is we're trying to grow income in the smokeable segment. We do that obviously through the operating plans of PM USA and if you look at it over time, I prefer back to some of the charts we showed perhaps at the Investor's Day meeting in June that the smokeable segment has really had pretty nice growth there over time and that's how we look at it, Thilo. We look at it over time. In some quarters, it's up a bit more and others in down and in others it's someplace else. But over time that's our strategy and I must say it seems to have worked relatively well and that's the strategy that we're pursuing. Thilo Wrede - Jefferies & Company, Inc.: Okay. And then last question I had for you. If I recall correctly I think you had described the strategy for L&M in the past as do you want to offset the share losses that you have had was basic over the last few years. When I look at the share data for your discount portfolio, it looks like those basic losses are offset by now. What's the plan going forward for L&M?

Well, I think the plan is what I described a moment ago which is it's got a role to play in our portfolio in the discount segment. And so you're right. We have described how it gathered up some share, the basic share as we made that brand more profitable. It's also gathered up some competitive share as you might expect for a great brand in that segment, but that's it role and our focus again remains on the premium end of the business. We're trying to make sure that Marlboro and other premium brands do great all the while making sure L&M is effectively executing the role it has in its place in the portfolio and I don't think that's going to change going forward. Thilo Wrede - Jefferies & Company, Inc.: Okay. Thank you.

Thanks for asking.

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

Hi. Good morning.

Good morning, Bonnie.

Hi. I just wanted to ask maybe another question on L&M. Just trying to understand if you see any cannibalization between L&M or your discount portfolio and non-premium level line extensions? And then I'd also like to hear how you're balancing the growth of your discount segment with margin expansion, how will you do that going forward?

Well, we're mindful of executing against the entire portfolio strategy of course as we are very, very mindful of Marlboro and our other premium brands we watched to make sure that L&M is playing the appropriate role, but we're not trying to grow the discount segment. Our focus is on premium. So that's always a balance on how we manage our brands as anybody does in their portfolio and that's how we think about it. We're a premium company. We sell premium brands. We get higher margin because of doing that. That's our strategy and that's what we'll continue to do.

Okay, that helps. And then, Marty, I would like to drill down a little further on something there, Marlboro line extensions. I'm hearing Southern Cut is performing well, so I'd like to hear more color from you on this? And then a question on Marlboro NXT expansion; as you role this out to more states, are you able to secure incremental shelf space or is this displacing existing shelf space for other Marlboro brands or possibly something else in your portfolio?

Okay, let me take those in turn. We're happy with Marlboro Southern Cut. It's a terrific product. It's got – and a terrific pack. It's been well received and I think it's been a great addition to the Marlboro family. The same thing with Marlboro NXT. You remember we launched that in two of our sales regions last year. It looks great. It's a terrific product. It's got a nice innovation on it with a capsule. It's been very well received. It's a nice addition to the Marlboro Black family. And this space, the share issue has always worked out by the trade programs and our trade programs take all of that into account as we work through the available space. But we haven't had, really I wouldn't think any difficulty in getting space for Marlboro NXT.

Okay. And then just my final questions on e-cigs and MarkTen. Given that tremendous success and the continued robust growth of the e-cig category, how concerned are you that you don't have a greater presence with your MarkTen e-cig yet? I guess meaning have you missed an opportunity or do you feel you can essentially play catch-up?

Well, I think the answer to that is, it's early days in the eBay per category and I think that MarkTen is a terrific product, it's a great brand. We've got a crackerjack sales force that will get us distribution where we need it. We'll learn. I think when we discussed this previously, that's how we think about innovation generally in e-cigarettes in particular which is – it's very exciting when these new products come along and they get a lot of attention. Our strategy is to maximize our core business while we take appropriate steps forward with innovation and that's a balance as well, but we have a big profitable mature business that does great. We have tremendous brands and so in the eBay per category, we want to learn our way in. I have no doubt that if we can get that product in the hands of consumers and get distribution and work the brand the way we've done over decades that we'll ultimately be very successful. I think this is a long game.

Right and you can leverage your existing sales force, as you mentioned, and you're willing to role this out quickly if your tests performs well. Is that fair?

We'll take the appropriate steps once we learn our way in. Certainly if it's well received, we always want to expand products that are well received by the consumer. And then as we discussed a moment ago as I'm sure you heard, there's some other reasons to be in which is – there's issues to be sorted through regulation and excise taxes in the like and we want to be at the table as they’re being sorted out.

Okay. That makes sense. Thanks so much.

Thanks, Bonnie.

Your next question comes from line of Chris Growe with Stifel.

Hey, good morning.

Hi, Chris.

Hi. I just had a couple of follow-up questions for you please. The first must be that I know you don’t like to give quarterly guidance, but would you expect the profit growth in your smokeable division to be up at a rate faster than the first half growth? I guess, what I’m coming down to is, you’ve had very good per pack growth in the first half. You’ve had roughly soft kind of absolute dollar profit growth in the first half however.

Well, you’re right. We don’t give quarterly guidance, and we’re not about to start this morning. I just had this conversation a moment ago about our strategy, which is to maximize income and we do that over time and you’re point out at the comparisons for this quarter or the quarter previous were a bit lower on that metric than they have been over the last several years. I think we showed during the Investor Day, again the history over time of how the income growth has been nice in smokeable. That continues to be our strategy. We’ve just given a revised guidance stock. Then all that is taken into account in our revised guidance.

Okay. Fair enough. Just two quick ones, and the first one with the likelihood of an FET it looks relatively small today. I guess, at least that – there will be a higher risk factor going forward given what’s proposed at least, do you have any comments on an FET, the likelihood and how you see that going forward?

Well we’re opposed to it and there has been talk about its relative movement or lack thereof. We’ve spoken previously, Gee-whiz; we just took an FET increase of a 158% or something in 2009. We saw what happened to the volumes and what happened to the trade. These are programs that are supposed to be for the benefit of everyone, but they’re proposed to be financed on the back of tobacco consumers and we just think that’s fundamentally unfair to say nothing of how regressive these taxes are. So, we’re being very mindful of that. We advocate strongly on behalf of our companies and our consumers on that. You’d hope that there is not much traction on it, if it doesn’t appear to be today, but we’re very careful about that.

Okay. And my final question is, in relation to your capacity for MarkTen and for e-cigarettes. Are you in the process still of building capacity that will make that product? I’m just thinking ahead to say a national launch, is there still some period of time that you need to build capacity to be able to handle a larger launch across the country?

Yeah. You forgive me for saying some of that’s proprietary, so I’m not going to talk about much of that. We certainly have capacity to execute what we intend to execute in Indiana and to do it well.

Okay. Thank you.

Thanks for asking.

We now welcome questions from media representatives on the call. (Operator Instructions) Your next question comes from the line of Todd Duvick with Wells Fargo.

Yes. Good morning.

Good morning.

Quick question for you on the balance sheet. You mentioned tapping the debt capital markets this past quarter and you have another $1.4 billion debt maturing in November. Can you tell us if the issuance from this past quarter was the partially refinance that or should we expect to see you either back in the market or look to issue commercial paper to take out this November maturity?

I’m not going to comment on our future debt plans. But I think you did point out that, I alluded to the $1 billion issuance in the second quarter. I think that gives us a fair amount of flexibility with regard to what actions we take for the $1.5 billion due later this year and then we’ve got about – we’ve had about $2 billion due between now and the end of the first quarter. And I think when we determine exactly what we were going to do there; we’ll announce it at the time.

Okay. And I guess, just a follow-up question to that. You still have a fair bit of very high coupon debt related to I think the UST acquisition in 2009. Do you continue to look at that as to see if that’s something you might want to address or you just planning to reduce your interest expense over time?

Well, I think certainly our goal is to work to reduce our interest expense over time, which we’ve been successful in doing. As you know we did tender for some of our high interest debt once before and I think we continue to look at all options, but we’ve made a definitive decision with regard to what we’re going to do going forward.

Okay. Thank you.

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

Okay. Good morning. Thank you for your time. Marty, I was going to ask you, if you could talk about your marketing plans for MarkTen. Can you help explain how you plan to balance selling the product with responsibilities that come with nicotine in a product that’s not regulated that sort of thing, I mean, how hard will you push your new – your e-cig in this lead market and what constraints will you take?

Thank you. That’s an excellent question. We’re working through all those details now. Let me take it in two parts perhaps. The first is you’re right, because for products that contain nicotine, you have to be responsible that how you do that. We thought deeply about that, including putting an appropriate warning on that product, which it will bear, despite the fact that it’s not currently regulated by FDA. The marketing mix is another matter altogether our target audiences, adult smokers and adult vapors and we want to get good reach to them. We want them to know about the product. We want to have good awareness to them, But we’ll also take steps to make sure that we’re not having unintended reach to audiences, we’re not trying to reach and that’s always a balance about how you do that. We are working through those marketing details now and I think when you see the execution, you will see that we’ve been quite comfortable with that.

Thank you.

Thank you. Good question.

Your next question comes from the line of Tim Milway with BlackRock.

Hi. Do you have any sense when the arbitration panel might release their decision regarding diligent enforcement?

Any day. That’s we were told. I mean, it’s mature and it’s right. So it could come at any time.

Right. Thank you.

You’re welcome.

Your next question comes from the line of Thomas Russo with Gardner Russo & Gardner. Thomas Russo - Gardner Russo & Gardner: Hi. Good morning. Question on the wine business, I’m wondering, just back from travels abroad and Chateau Ste. Michelle and others of your brands have been gaining a presence in Asia. And I’m wondering just to what extent the division is prepared to invest behind that, what they see as a future there for the returns of the capital?

Sure. Tom, I think your observation is accurate, which is we’ve had greater volume of our key brands sold in Asia given the – given kind of the affordable premium positioning of our brands, I think they’re well positioned for the Asian market and that has been an initiative that the wine company is focused on certainly over the last couple of years. And I think we’ll continue to, because certainly wine is becoming more popular amongst the middle class in China and other Asian countries. Thomas Russo - Gardner Russo & Gardner: Thank you.

Thanks for calling Tom.

(Operator Instructions) At this time, we’ve no further questions. I’d now like to turn the floor back over to Michael Neese for closing comments.

Thank you for your time today. The IR team is available for any additional questions you may have. This concludes our call.