5 Things Altria Management Wants You to Know

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The secular decline in cigarette smoking in recent decades has done little to slow the growth of tobacco giant Altria Group (NYSE: MO). So far, the Marlboro maker has been able to take steps to offset long-term trends toward falling sales volume, using its pricing power and brand loyalty to defend its business. Following its second-quarter earnings report, Altria executives sat down with analysts to give more detail about the company's strategy and the near-term issues that Altria is facing right now. Here are five things they discussed that every investor should know about Altria.

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1. Taxes hurt Altria

The smokeable segment's results were negatively impacted by California's $2 per pack cigarette excise tax increase. ... Past experience shows that tax increases of this magnitude are most disruptive immediately following implementation, after which the rate of decline moderates.

Hard-hit state governments are always on the lookout for sources of tax revenue, and the tobacco industry has been a perennial target in many states. Last year, California became the latest state to impose new tobacco taxes, adding $2 to its existing excise tax. The move passed despite Altria's attempts to convince the public not to vote for the measure.

Similar measures in several other states were defeated, showing some success for Altria. Yet California was responsible for 7% of U.S. cigarette volume throughout the industry before the increase, and Marlboro's strong share there hit Altria particularly hard. Altria thinks that the impact from the move will ease, but it still sees a 1-percentage-point hit to industry sales volume for 2017 as a result of California's move as well as a previous one in the state of Pennsylvania in late 2016.

2. Smokeless tobacco bounces back

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USSTC has largely rebounded from its first quarter product recall. ... Now that the product recall is complete and trade inventories are substantially replenished, USSTC is well positioned moving into the second half of the year.

Altria's U.S. Smokeless Tobacco Company division suffered a blow earlier this year when it had to recall certain smokeless tobacco products made at its production facility in Franklin Park, Illinois. Consumer complaints indicated foreign objects in smokeless tobacco containers, leading to the recall of some of its Copenhagen, Skoal, Husky, and Cope brand products. Altria handled the issue quickly, and although the event was costly and resulted in a hit to performance in the first quarter, company management believes that any negative impact was short-lived. The boost to Copenhagen's retail market share during the second quarter supports that view, getting the brand back on track to build positive momentum.

3. Altria moves toward menthol

Looking to the back half of the year, PM USA recently announced the national expansion of Marlboro Black Menthol 72s, a product PM USA expects will further enhance Marlboro's position in the growing menthol segment and among adult smokers aged 21 to 29.

Historically, menthol-flavored cigarettes haven't been as high a priority for Altria as they have for some of its competitors. Yet perhaps in response to the recent merger of Reynolds American and British American Tobacco (NYSE: BTI), Altria has recently looked to compete more strongly in menthol, going up against BAT's leading Newport brand. What's interesting about the move is that it comes amid continued consideration by regulators for limits on menthol cigarettes. Groups of lawmakers on Capitol Hill recently reiterated their desire for a menthol ban, yet Altria's move suggests that the company believes those efforts will remain unsuccessful.

4. Uncertainty about iQOS continues

We're preparing to be ready on the nominal timelines that the FDA has set with respect to approving those applications. ... We're going to be ready at the earliest moment to proceed expeditiously.

Altria noted that the U.S. Food and Drug Administration continues to consider the modified risk tobacco product application for the iQOS heated-tobacco system. Yet with the comment period set to go on through December, no decision will be made before 2018, and it could realistically take several years for the FDA to come out with a final announcement. Altria CEO Marty Barrington said that the company has contingency plans in place to deal with potential delays, but it's still hoping to take full advantage of the opportunity while maintaining other investments in alternatives to traditional cigarettes.

5. MarkTen is gaining ground

In e-vapor, Nu Mark's MarkTen brand continues to grow volume and retail share. ... We're pleased with MarkTen's progress, and Nu Mark plans to continue growing the brand in the back half [of 2017].

Largely lost in the excitement over iQOS have been Altria's other strategic innovations in the alternative products category. The Nu Mark division has worked hard to promote MarkTen e-cigarettes, helping make it the No. 2 e-vapor brand nationally and achieving a 13% national retail market share in mainstream channels. Altria has gotten MarkTen into a wide variety of stores that make up almost two-thirds of all e-vapor sales volume, and as retail share in those stores approaches the 25% mark, Altria is excited about the potential for future growth.

Altria faces plenty of challenges, but it's meeting them head-on. So far, Altria's efforts appear to be paying off well, and investors have to be pleased at the way the company is aiming to keep growing by taking advantage of all of its opportunities.

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