Will 2017 Be Altria Group Inc.'s Worst Year Yet?

By Dan Caplinger Markets Fool.com

2016 was a strong year for Altria Group (NYSE: MO), with the stock jumping 20% to be among the best performers in the tobacco industry. Overall, the cigarette giant has done a good job of finding ways to maximize its profits, and there are reasons why bullish investors think that Altria could sustain its positive momentum in 2017. Yet Altria also faces challenges, and if it makes a misstep, then 2017 could easily become a nightmare year for the company. Let's take a look at what it would take to turn 2017 into Altria's worst year yet.

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Image source: Altria Group.

Rising gasoline prices could hurt cigarette demand

Like its tobacco industry peers, Altria relies on sales of cigarettes and other tobacco products at gas stations and convenience stores for a substantial portion of its overall revenue. According to one executive, convenience stores drive 70% of volumes sold, with 160 million consumer transactions taking place there every day. That leaves the company exposed to changes in discretionary income among consumers, and customers' purchasing decisions are sensitive to what they have to pay at the pump and therefore how much they have left in their wallets after filling up.

That fact gave Altria a considerable boost in 2015 and 2016, as gasoline prices fell and remained low. As CEO Marty Barrington noted in early 2016, the combined impact of low unemployment, rising housing starts, and low gasoline prices helped improve adult tobacco consumer confidence. However, executives have noted that those tailwinds are waning as year-over-year comparisons become less favorable.

In recent months, the energy industry has recovered, and gas prices have started to rise. According to the latest figures from AAA, average national gas prices are currently at $2.36 per gallon, up $0.15 in just the past month and nearly $0.40 per gallon higher than where they were at this time last year. If that trend continues, it could reduce the amount of money customers have left to spend on cigarettes, spurring a reversal of some of Altria's growth in the past couple of years.

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Competition could get fiercer

One major outstanding question that could affect Altria is whether rival Reynolds American (NYSE: RAI) ends up making a deal with minority-owner British American Tobacco (NYSEMKT: BTI) to do a full merger. British American made an attempt to buy the remainder of Reynolds American late last year, but Reynolds didn't accept BAT's initial offer. Thus far, the two companies haven't reached any further agreement, yet some believe a deal is inevitable.

If Reynolds and British American combine, it could create more competition in the U.S. market. In particular, BAT argued that a merger would give the combined company not only a leading position in the U.S. tobacco market but also dramatically improved research and development capabilities that could spur further product development. In particular, with next-generation products like e-cigarettes starting to gain traction across the globe, Reynolds and BAT could work together to pose a bigger threat to Altria and its Nu Mark e-cigarette line. Altria has resources of its own to rely on, yet a stronger Reynolds would still make Altria's job that much harder.

Strapped state governments could turn to higher cigarette taxes

Finally, Altria investors will have to watch the political environment very closely in 2017 to see how things shape up. The federal government appears unlikely to make any changes to cigarette and tobacco taxes in the immediate future, but state governments will face more challenges in order to make their budgets work. Cigarette taxes have been a popular go-to revenue source for many states in the past, with the most recent example being California and its $2 per pack tobacco tax hike that voters approved in November.

Interestingly, low gasoline prices could be one reason why Altria and other tobacco companies might eventually face higher taxes. Revenue from gasoline taxes in some states is tied to the price at the pump, and low gas prices have strained some budgets. Meanwhile, the need for road and infrastructure spending has grown. With the state of Indiana already looking at a possible cigarette tax increase, Altria will have to work hard to fight it and other proposals as they come up.

Altria did well in 2016, but some aren't as certain about whether it can keep up its strong performance in 2017. If these things go wrong, then 2017 could be one of the toughest years ever for the cigarette giant.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.