Altria (MO) missed our volume estimates in the third quarter, leading to a disappointing top line, but beat our estimates at the gross margin. The net effect was that gross profit, operating profit and adjusted earnings were all marginally better than our forecast. We are retaining our $52 per share fair value estimate.
Consolidated net revenue fell by 2.6% year over year, driven by a steep 12.9% decline in smokeable segment volume. We had expected a sequential volume deterioration from the adjusted decline of 4.5% in the second quarter, due to trade inventory movements, but this was disappointing relative to our expectations of flat net revenue. However, price/mix of 10.3% and the 90 basis point year-over-year improvement in gross margin to 66.4% were both impressive, and suggest that the competitive environment became less promotional during the quarter. This supports our belief that the tobacco industry will provide investors with a safe haven from the inflationary pressures that are likely to affect most other consumer product manufacturers during the next few quarters. In the medium term, however, we think a near-13% cigarette volume decline rate is unsustainable, in the absence of material heated tobacco volume growth to mitigate the shipment contraction, and we expect Altria to attempt to achieve more of a balance between volume and margins.
Altria's non-cigarette portfolio posted steady growth in the third quarter. The rollout of iQOS continued, with heatsticks volume up 20%, despite the uncertainty into the commercialization of iQOS products created by the International Trade Commission ruling against Altria in September. The worst-case scenario, in our view, is that Altria will face delays of a few quarters until it can bring to market heated tobacco technology that circumvents the patent ruling, subject to approval by the Food and Drug Administration. In oral tobacco, on! nicotine patches grew to 3% oral tobacco category share thanks to expanded distribution.
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