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Morningstar | Marlboro Stabilizes in 3Q; E-Cig Product Withdrawal Immaterial to Altria

Altria reported a decent third quarter, beating our estimates on volume, which trickled down to a modest beat at the bottom line as well. Encouragingly, Marlboro appears to have stabilized, in line with our medium-term assumptions, and we reiterate our wide moat rating and $64 fair value estimate.

Altria's net revenue excluding excise taxes increased by 3.3%, driven by a 7.2% increase in the smokeable business. Cigarette volume declined by 3.7%, helped by the improved performance of Marlboro, which fell by 3.2%, a sequential improvement from the 7.2% decline in the first half of the year and likely boosted by the company's brand investments, which include digital consumer engagement. Behind the headline numbers, though, trade inventory movements artificially supported the growth figures, and we believe Altria's retail volumes to have declined at around 5%, in line with recent trends, suggesting that e-vapor is still taking share from cigarettes. The discount segment remains under pressure (Altria's third-quarter discount volumes were down 6.8%), and we do not anticipate that trend changing while gas prices remain relatively high. Once again, the smokeless segment outperformed cigarettes, with 7.2% net revenue growth on volume growth of 0.4%.

The third-quarter EBIT margin was slightly below our forecast, however, due to the heavy brand spending behind Marlboro. Still, with no sign yet of approval from the U.S. Food and Drug Administration, or FDA, for the marketing of iQOS in the U.S., investment spending is lower year-to-date than it would have been had approval been granted earlier in the year, as implied by the company's guidance. Assuming approval is forthcoming by year-end, as anticipated, that spending will likely be pushed into 2019.

Altria announced that it is to withdraw its pod-based vaping products, MarkTen Elite and Apex, which may be contributing to youth consumption of e-vapor. From a financial perspective, we think this is likely a net benefit, as we believe these products are negative-margin for Altria, and given that Altria's portfolio has lost significant share to Juul, which now dominates the U.S. market with a share of around 70%, it appears unlikely that these brands will ever achieve the scale to make them profitable. Nevertheless, management has the option to apply for a premarket tobacco application with the FDA that, if granted, would allow it to relaunch the products in the future. This is a strategy we expect to be deployed if upcoming regulations in the vaping category have a disproportionately negative impact on Juul, which may provide an opportunity to other manufacturers to regain lost share.