JohnnyPowell
Introduction
British American Tobacco p.l.c. (BTI, OTCPK:BTAFF) shocked traders on December 6, 2023, with the announcement of a £25 billion impairment cost, primarily referring to its U.S. manufacturers acquired in 2017 (Reynolds American Inc.). The cost primarily resulted from a change within the financial life evaluation from an infinite interval to a interval of 30 years. For many who have an interest, I’ve coated this matter in a separate article on BTI.
Though an impairment cost was anticipated sooner or later, it conveys the message that the U.S. cigarette trade is in a worse state than beforehand thought. That is largely attributable to the post-pandemic accelerated quantity decline and the rising significance of smoke-free alternate options. Therefore, and because of the looming ban on menthol-flavored cigarettes and different flavored tobacco merchandise (the choice was recently postponed), BTI’s administration needed to write down the worth of its cigarette manufacturers, which embrace the market chief in menthol – Newport.
Nonetheless, as Altria Group, Inc. (NYSE:MO) is the one main tobacco firm that solely sells its merchandise within the U.S., BTI’s impairment could possibly be an indication of doubtless critical hassle. I’ve mentioned the continued have to offset declining cigarette volumes with value will increase (towards the backdrop of accelerating value elasticity of demand), but in addition the more and more restricted headroom for margin enlargement in different articles (right here and right here) and so won’t tackle this subject on this replace.
As an alternative, I’ll take an in depth take a look at Altria’s newest steadiness sheet and clarify why Altria – in contrast to British American – won’t be taking an impairment cost in relation to its cigarette enterprise. As well as, I’ll quantify the anticipated affect of the ban on menthol cigarettes, as Altria may be very uncovered to this phase.
Why Altria Will Not Take An Impairment Cost On Its Cigarette Enterprise
On the finish of the third quarter of 2023, the carrying worth of Altria’s goodwill and different intangible property amounted to $20.5 billion, or about 56% of complete property. Whole intangible property consisted of the next:
Determine 1: Altria Group, Inc. (MO): Composition of the intangible property steadiness on the finish of Q3, 2023 (personal work, primarily based on firm filings)
Over the course of the primary 9 months of 2023, the steadiness elevated by roughly $3.0 billion, which is attributable to the acquisition of NJOY Holdings. The $2.9 billion transaction added a complete of $1.3 billion of identifiable internet property to Altria’s steadiness sheet, of which $1.4 billion is attributable to amortizable intangible property (expertise, logos and provider agreements). The distinction is basically attributable to $167 million in deferred revenue taxes and $27 million in accrued bills and accounts payable. The distinction between the entire consideration and the online asset worth ($1.6 billion) was acknowledged as goodwill on Altria’s steadiness sheet.
This leaves a complete of $17.5 billion in intangible property (30% goodwill), which justify a better look.
The lion’s share of Altria’s intangible property excluding goodwill ($12.3 billion, excluding NJOY) is attributable to logos associated to the acquisition of UST Inc. in 2009 ($8.8 billion, snuff and chewing tobacco). $2.6 billion is attributable to manufacturers associated to the John Middleton Inc. enterprise (cigars), which Altria acquired in 2007. These are property with indefinite helpful lives that can’t be amortized. There stay $947 million of intangible property, most (or all) of which have a particular helpful life and are amortized over a weighted-average interval of roughly 18 years. These property embrace mental property and sure cigarette and e-vapor manufacturers in addition to buyer relationships and provider agreements.
Of the $5.2 billion goodwill attributable to acquisitions aside from NJOY, $5.1 billion is attributable to the oral tobacco merchandise phase (moist smokeless tobacco – MST – and snus merchandise). Goodwill attributable to Altria’s smokeable merchandise portfolio (<2% of complete goodwill, excluding NJOY) has not modified since year-end 2022. The 2022 10-K incorporates a way more detailed presentation of goodwill and exhibits that of the $99 million, $22 million is attributable to the cigarette enterprise and $77 million to the cigar enterprise.
I acknowledge that this was most likely loads of accounting phrases and loads of numbers, however the message could be summarized right into a single conclusion:
Altria has no materials intangible property associated to cigarette manufacturers on its steadiness sheet – both within the type of goodwill (consideration paid on high of internet property) or different intangible property (e.g., logos and provider relationships). Subsequently, and provided that British American’s impairment primarily associated to a few of its acquired U.S. cigarette manufacturers (e.g., Newport, Camel), it might be unreasonable to anticipate Altria to acknowledge an impairment on its (de facto non-existent) cigarette-related intangible property.
On the similar time, because of this Altria – in contrast to British American Tobacco – won’t profit from important amortization fees. As I mentioned within the replace underneath my final article on BTI, the corporate will be capable of take annual amortization because it has modified the financial lifetime of its U.S. cigarette manufacturers to 30 years. Contemplating that greater than £60 billion of BTI’s intangible property (excluding goodwill) are attributable to cigarette manufacturers, this presents a really compelling alternative to scale back the corporate’s tax burden. Nonetheless, as I’m not an knowledgeable on U.Ok. tax legal guidelines, please take this data with a grain of salt.
Turning again to Altria, whereas an impairment on cigarette manufacturers (e.g., Marlboro) could be de facto dominated out, it’s nonetheless doable that the corporate will take an impairment on its Middleton cigar enterprise eventually, primarily because of the anticipated ban on flavored cigars (see FDA proposal and Middleton’s portfolio). Nonetheless, ought to Altria comply with the identical path as British American and acknowledge the Middleton logos as a finite-lived intangible asset, it’s fairly doable that the corporate may gain advantage from recurring amortization over the anticipated remaining helpful lifetime of the asset. Nonetheless, I wish to reiterate that I’m not an knowledgeable on tax legal guidelines, however in keeping with this article, it is extremely probably that Altria can profit from associated tax deductions supplied the asset is amortized over 15 years.
Assessing The Potential Influence Of The Menthol Ban
Altria doesn’t report volumes or income from menthol cigarette gross sales in its quarterly updates. Nonetheless, Altria reviews its retail share of menthol cigarettes on a quarterly foundation, which was 9.2% within the fourth quarter of 2022 and averaged 9.33% for the yr 2022. Altria’s complete retail share within the cigarette phase was 47.9% in 2022.
In my estimate, I’ve assumed that standard cigarettes and menthol-flavored cigarettes are offered on the similar costs. In fact, this doesn’t bear in mind the contribution of the cheaper low cost cigarettes. Nonetheless, contemplating that Altria’s market share in low cost cigarettes was solely 3.1% in 2022, I believe the error launched by this approximation is negligible. I additionally needed to approximate the contribution of cigar gross sales. Given the hardly important contribution to the entire quantity of smokeable merchandise (1.7 billion sticks in comparison with a complete of 84.7 billion sticks shipped in 2022, i.e., 2%), I believe one can conclude {that a} 2% gross sales contribution to the smokeable merchandise phase is a reasonably affordable approximation. Lastly, I made the (pretty conservative) assumption that every one of Altria’s cigar gross sales are flavored cigars and thus might doubtlessly be banned.
It follows that in 2022, about 17% of internet revenues probably got here from menthol-flavored cigarette gross sales and a couple of% of internet revenues got here from (assumed flavored) cigar gross sales. Contemplating that Altria’s oral tobacco merchandise phase is probably going not worthwhile, most, if not all, of the corporate’s free money move (at the moment about $8.2 billion yearly) comes from the sale of cigarettes and cigars. Consequently, ought to the ban go into impact, Altria might lose 21% of its free money move, which might carry its dividend payout ratio to only over 100% – Altria would probably have to chop its dividend.
Determine 2: Altria Group, Inc. (MO): Estimated 2022 phase internet revenues (personal work, primarily based on firm filings)
Nonetheless, it’s too conservative to imagine that every one former menthol people who smoke stop with the enforcement of the ban. A recently published study from Canada (menthol cigarettes had been banned between 2015 and 2018) discovered that round 22% of former menthol people who smoke efficiently stop their behavior. Which means that 4 out of 5 have both switched to common cigarettes (right here I see Marlboro positively positioned as a result of its present availability with and with out menthol) or to different alternate options (right here I see BTI and shortly Philip Morris Worldwide (PM) better off as a result of their smoke-free portfolios). The authors of the examine additionally estimated the potential affect of a menthol ban on the U.S. market and concluded that greater than 1.3 million people who smoke would probably stop (or lower than 5%, primarily based on the CDC’s 2021 data).
Taken collectively, a cessation charge of lower than 5% (estimate for the U.S.) and 22% (knowledge for Canada) would result in a lower in free money move of two.3% to five.2% (Determine 3). This assumes that every one people who smoke who swap to an alternate cigarette model stay loyal to Altria manufacturers. Nonetheless, even when this isn’t totally the case, I consider the affect on free money move will almost certainly stay manageable. Therefore, I believe Altria can preserve its dividend and proceed to develop it at a low single-digit charge. In fact, this state of affairs evaluation doesn’t bear in mind the proceeds from a possible sale of Altria’s stake in Anheuser-Busch InBev SA/NV (BUD), which might considerably scale back Altria’s leverage and enhance its dividend payout ratio as a result of share buybacks (see this text).
Determine 3: Altria Group, Inc. (MO): Situation evaluation modeling the potential affect of a ban on flavored tobacco on free money move (personal work, primarily based on firm filings, Fong et al. 2023 and personal calculations)
Key Takeaways
An in-depth evaluation of Altria’s newest steadiness sheet has proven that, in contrast to British American Tobacco p.l.c., the corporate won’t acknowledge any impairment of goodwill or different intangible property associated to its cigarette manufacturers for one easy purpose: there are not any materials associated property on Altria’s books. On the similar time, Altria will be unable to learn from ensuing amortization fees, that are additionally more likely to be tax related underneath U.Ok. tax regulation.
In fact, this doesn’t imply that Altria’s cigarette enterprise is in a greater place than that of British American. Along with the trade headwinds, each firms’ gross sales (and due to this fact free money move) are more likely to undergo if the ban on flavored smokeable tobacco merchandise is carried out, as each are considerably uncovered to menthol cigarettes (and Altria additionally to flavored cigars).
In keeping with my very own estimates, Altria generates about 17% and a couple of% of its internet gross sales from menthol cigarettes and cigars, respectively. Assuming that Altria’s gross sales would decline by these percentages after the ban, the corporate’s dividend payout ratio would exceed 100% of free money move.
Nonetheless, this expectation is simply too conservative, because it assumes a 100% cessation charge of former menthol people who smoke and that 100% of the cigars offered by Altria are flavored and, due to this fact, banned. Assuming an affordable cessation charge vary of 5% to 22% (as famous in a latest examine), however nonetheless assuming an entire lack of cigar-related gross sales and money flows, Altria’s consolidated free money move might decline by roughly 2.3% to five.2%. Because the dividend payout ratio won’t be affected an excessive amount of underneath these assumptions, it may be assumed that Altria Group, Inc. will proceed to pay out – and slowly enhance – its beneficiant dividend (present yield 9.5%). In fact, this doesn’t but bear in mind the constructive results of a doable sale of its stake in Anheuser-Busch.
Thanks for taking the time to learn my newest article. Whether or not you agree or disagree with my conclusions, I all the time welcome your opinion and suggestions within the feedback beneath. And if there’s something I ought to enhance or develop on in future articles, drop me a line as nicely. As all the time, please contemplate this text solely as a primary step in your individual due diligence.
Editor’s Observe: This text discusses a number of securities that don’t commerce on a significant U.S. change. Please pay attention to the dangers related to these shares.