Altria's Q3 Shows Why Tobacco Sector Is Misunderstood

Altria MO reported another robust performance in the third quarter, as evidence is gathering that tobacco has been one of the more defensive categories during the pandemic. Consolidated net revenue grew by 4.9% year over year on the back of a modest 2% underlying cigarette volume decline. Adjusted operating income grew by almost 9% over the same period a year ago, implying EBIT margin expansion of 2.2 percentage points, and adjusted earnings per share was flat. Given the lack of visibility into the near-term performance of many businesses, we are surprised that the market seems to have overlooked this resilient performance, and we think Altria is both mispriced and misunderstood. We are retaining our $54 fair value estimate and wide moat rating.

We estimate underlying cigarette shipment volume was down by 2% in the third quarter, offset by 6% pricing. This is a significant improvement from the 4% to 5% decline of recent years, for three reasons, in our view. First, the temporary effect of smokers staying at home and having more time and discretionary income to spend on smoking is increasing the frequency of consumption. This tailwind may ease after the pandemic passes. Second, the stabilization of Altria's premium price segments after losing share to the discount segment in recent quarters. Third, the structural effect of nicotine consumers switching back to smoking from vaping, following the clampdown on flavored liquids by the Food and Drug Administration, or FDA. While it is difficult to quantify the impact of these factors, and management has again refrained from reinstating medium-term guidance, we believe our medium-term estimate of a 3.5% annual volume decline in a normalized environment remains realistic, and assumes the vaping category does not materially rebound.

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