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Altria Isn't Giving Up on Traditional Cigarettes

Rich Duprey, The Motley Fool

The future of cigarettes may be smoke-free, but tobacco giant Altria (NYSE: MO) wants investors to know it's still investing in regular cigarettes to maximize income. Its Marlboro brand may have lost some market share in 2017, but it remains the leader by far and is still highly profitable.

While Altria, like the rest of the industry, will continue to invest in and grow its smokeless products, including the next-generation reduced-risk products, the regular combustible cigarette market continues as it has been and Altria will make the most of it.

Cigarette production underway at tobacco factory.

Image source: Getty Images.

Marlboro Man still rides high

Speaking at a recent analyst conference, Altria president, chairman, and CEO Marty Barrington said that over the past five years, the tobacco company's smokeable products segment, which includes Philip Morris USA, John Middleton, and Nat Sherman, grew adjusted operating income at a compounded annual rate of 6.4% while margins grew 10 percentage points to 51.2%.

Through it all, Marlboro was and is the leading brand in the cigarette category, bigger than the next nine brands combined. Between 2011 and 2016 the familiar red-and-white cigarette pack grew its market share by an average of two-tenths of a share point annually, but slipped in 2017, giving up four-tenths of a share point, due primarily to the California excise tax increase, but also because of increased competition from the discount market.

The cigarette industry as a whole saw volumes decline by about 4% last year, including approximately a 1% impact from state excise tax increases in California and Pennsylvania. Those tax hikes, which Altria offset by hiking its own prices last March, helped fuel a drive toward the deep discount end of the market.

Leading discount cigarette manufacturer Vector Group (NYSE: VGR), which owns brands that include Eve, Grand Prix, and Pyramid, seems to have been a particular beneficiary of the switch as it recorded a 7% jump in revenues during 2017 thanks to an 8.1% increase in unit sales volumes. Its Eagle 20's brand is now the third largest and fastest growing U.S. discount brand, a huge leap considering it was only launched in 2013.

Tobacco leaves drying from hung lines.

Image source: Getty Images.

A new push in traditional cigarettes

Altria remains undeterred in the prospects for Marlboro and combustible cigarettes generally, and despite the gains made by the deep discount end of the market, COO Howard Willard says "the fundamentals (of the industry) are essentially unchanged." While gasoline prices, excise taxes, and the broader economy need to be watched closely, the adult cigarette consumer is still the same.

Still, to help stabilize Marlboro's place in the market, Altria's Philip Morris USA division will be developing new products and packaging, enhancing trade programs, and increasing Marlboro promotions.

It's testing a Marlboro Black Label non-menthol cigarette in two states and is expanding Marlboro Ice menthol cigarettes nationally. It's also redesigned the Marlboro website with new digital tools while using store loyalty programs at its retail partners, as well as a new rewards program for Marlboro.

It didn't put a price tag on how much it's investing to reverse Marlboro's losses, but notes that after paying dividends, it typically has about $1 billion in cash remaining each year that it uses to buy back shares and invest in the business. This year it also received a benefit from President Trump's tax reform program and it plans on reinvesting about one-third of the total received.

With shares of Altria down 15% over the past year, it just increased its dividend 6% to $2.80 per share, implying a dividend yield of 4.45%. It also marks the 52nd time Altria has increased its dividend in the last 49 years, making it an attractive investment considering the profitable, long-term growth prospects it still has before it.

Trading at 18 times earnings and 14 times next year's estimates, there seem to be more than a few puffs left on the stub of this tobacco giant.

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