Why Altria Group Just Took an Earnings Hit

By Markets Fool.com

Many investors focus huge amounts of attention on the quarterly results of the companies whose shares they own, looking closely for signs of imminent problems. Occasionally, though, companies offer early looks at events that affect their financials, especially if they anticipate a negative impact on their bottom line. Earlier this week, Altria Group (NYSE: MO) warned that it would have to take a sizable charge against its third-quarter earnings, which it expects to announce late next month. Yet even though the charge will reduce Altria's quarterly earnings significantly, most investors are taking the news fairly calmly. Let's take a closer look at what Altria said and what's behind the one-time charge.

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Image source: Altria.

Altria restructures its debt

If you were just looking at headlines related to Altria, you wouldn't have seen anything that would have suggested a drop in earnings. Indeed, the main point that the tobacco giant made in its press release was that it was reaffirming its full-year earnings guidance.

However, when you look more closely at the release, you'll notice that it discusses a one-time pre-tax charge against earnings that the company will record in the third quarter. Specifically, Altria said that it would take an $825 million hit to its bottom line, working out to $0.28 per share. Given that most investors were expecting Altria to earn roughly $0.80 per share during the quarter, the charge is a significant reduction to the company's GAAP results.

Why Altria is taking a charge

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The reason that Altria had to warn of a pre-tax charge is connected with its decision to make a tender offer to extinguish some of its long-term debt. Altria had sought to buy back bonds with an outstanding principal amount of about $1.4 billion, maturing in 2038 and 2039 and carrying interest rates of about 10%. As part of the tender offer, Altria agreed to pay an amount closer to the current market price of the bonds. As you can imagine, that amount is much higher than the principal amount of each bond, given how attractive double-digit interest rate yields have become in an era of low rates.

Altria announced the final results of the tender offer as part of its press release. In total, bondholders agreed to tender about $934 million in principal value, or close to two-thirds of what Altria would have been willing to buy. The value of the bonds was calculated at between $1,840 and $1,880 per $1,000 in principal value. As a result, Altria will end up paying about $1.74 billion in order to retire that debt. That added amount -- reflecting the premium value of the bonds -- is roughly equal to the charge that Altria will take.

Short-term pain, long-term benefit

Altria's move is part of an overall strategy to restructure its debt. At the same time as the tender offer, Altria also offered new long-term bonds. The new bonds included terms of between 10 and 30 years, and interest rates ranged from around 2.625% to 3.875%. Altria therefore anticipates that it will spend less on interest expense and extend the overall average duration of its outstanding debt, taking full advantage of low interest rates while they last.

In essence, what Altria is doing is exchanging a one-time hit to earnings now for better earnings results later. Once the tendered debt is extinguished, Altria will pay incrementally less in interest expense each quarter, boosting earnings by a small amount. Unlike the one-time charge, Altria will build the interest savings into its adjusted earnings, giving investors the impression that its business conditions have improved. In reality, all Altria did was to accelerate the impact of high rates, paying now to save later.

Most Altria investors will ignore the one-time charge to earnings, looking instead at adjusted results when Altria announces its third-quarter financials next month. Yet it's important to keep an eye on charges, because they often represent real money that a company has lost. In Altria's case, refinancing its debt has merit, but it still comes at a cost, and investors need to stay aware of that cost in assessing the tobacco giant's financial success.

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