Lowering Our Fair Value Estimate for Altria

Altria's MO fourth-quarter and full-year 2019 results were in line with our forecasts, reflecting another year of above-average volume declines. Volumes missed expectations slightly, although pricing was stronger. The big news was another $4.1 billion impairment charge on the Juul Labs investment, as management renegotiated the terms of its cooperation agreement with the electronic cigarette maker. We are skeptical that Juul will ever generate material cash flow for Altria and have removed the assumption of equity income from our valuation. Accordingly, we are lowering our fair value estimate to $54 per share from $56. The magnitude of the market's reaction--Altria's market valuation declined by 4% on the news--seems appropriate, but we still believe the shares are undervalued. We retain our wide-moat rating for the company.

Revenue fell by 1.8% in the fourth quarter and by 1% in the full year, as pricing did not quite fully make up for another year of above-historical average volume declines. Longer term, the robustness of price elasticity gives us conviction that revenue can grow at a very low-single-digit rate, because even if total volume declines were to linger at around 5%, we think long-term pricing could more than offset that. This could occur if new products fail to capture the volumes lost by high rates of smoking cessation. The short term has several moving parts: the smoking age limit increase to 21 in the United States at the federal level is likely to accelerate the volume decline in 2020, while the decline of the vaping category (industry volumes were down 8% in the fourth quarter) could provide a boost to cigarette volumes this year.

The fourth-quarter operating margin of 50.5% narrowly missed our forecast, most likely due to soft volumes. We remain comfortable forecasting a fading margin over the next five years, but it is possible that investments in lower-scale emerging categories could provide further margin downside in the near term.

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