Altria Snuff Plan Snubbed by Investors Seeking Growth

Source from:  By Chris Burritt June 12 (Bloomberg) 06/12/2008

Altria Group Inc., the maker of Marlboro cigarettes, may fall short on replacing growth lost through the spinoff of Philip Morris International Inc. in part because of its slowness in developing smokeless tobacco products. Without the international unit that contributed about two- thirds of Altria's $13.2 billion in operating profit, the biggest U.S. tobacco seller is left to look for additional sales in a market where health-conscious consumers are smoking less and other buyers are cutting back as taxes push up cigarette prices. Altria pledged before the March 28 spinoff to enter the faster-growing, $3.7 billion market for snuff and snus, a finely ground tobacco placed in the mouth that doesn't require the user to spit, through product development and a possible acquisition. Instead, Chief Executive Officer Michael Szymanczyk, 59, told the annual meeting on May 28 that the Richmond, Virginia- based company would grow "organically" because it "can start at the beginning and understand the consumer profiles." Altria has been testing sales of smokeless products in Atlanta, Dallas and Indianapolis. The company "may no longer have the luxury to take a wait- and-see attitude because of higher taxes and the industry's expansion into the smokeless category," said Thomas Russo, who oversees more than $3 billion at Gardner Russo & Gardner in Lancaster, Pennsylvania. He held 5.7 million Altria shares as of March 31. Earnings Increase The company expects 2008 per-share earnings to rise 9 percent to 11 percent, Szymanczyk told the annual meeting. He declined to comment for this article. Altria has other ways to expand besides smokeless tobacco, according to Filippe Goossens, a Credit Suisse analyst in New York. Cigarette-price increases, $1 billion in cost cuts and $7.5 billion in buybacks over two years will help provide enough growth for the company to meet its annual return target of more than 12 percent, he said. To have growth in the smokeless category isn't "an absolute strategic imperative," said David Adelman at Morgan Stanley in New York. He is ranked first among analysts who follow the stock, based on his recommendations' rate of return. "It could be a driver of revenue and profit growth, which is why they're spending money to learn about the category," said Adelman, who downgraded the shares to "equal-weight" from "overweight" on April 1. Altria rose 22 cents, or 1.1 percent, to $20.94 at 4:15 p.m. in composite trading on the New York Stock Exchange. The shares are down 8 percent since March 28. Acquisitions Necessary Acquisitions have been the preferred means of entry in the smokeless market, which is dominated by the Skoal and Copenhagen brands from UST Inc.Reynolds American Inc. bought snuff maker Conwood Co. in 2006 and is selling Camel snus in New York and 16 other cities. British American Tobacco Plc, based in London, agreed in February to buy most of Denmark's Skandinavisk Tobakskompagni A/S for $4 billion. Some shareholders had expected Altria to make a bid for either Stamford, Connecticut-based UST or Stockholm-based Swedish Match AB, according to Goossens. Such a bid is "highly unlikely" in the next 12 months, he said in a May 13 note to clients. Goossens rates Altria's stock "outperform" and is ranked third by rate of return. "The market believes ultimately that Altria may not be able to develop a successful organic smokeless strategy in a time frame that's required to offset declines in traditional cigarettes," Goossens said. "The market believes they will have to expand by means of acquisition." Short Interest Altria fell as much as 5.6 percent on April 1 after being downgraded by Morgan Stanley's Adelman. Judy Hong, an analyst at Goldman, Sachs & Co., removed Altria from the firm's "Americas conviction buy" list later that month. Both analysts said they didn't see management moving aggressively enough to boost the share price. In another sign of investor pessimism, short interest is at the highest since mid-December. In a short sale, investors sell borrowed shares and attempt to profit by repurchasing them later at a lower price. Altria expects domestic cigarette shipments to fall about 3 percent this year as prices rise and more people stop smoking. U.S. consumers smoked an estimated 360 billion cigarettes last year, down 3.2 percent from 2006. Consumption has fallen 31 percent since 1990. Prices Rise While dwarfed by the $70 billion spent on cigarettes in the U.S. annually, the smokeless market is expanding at as much as 6 percent a year, according to UST. Reynolds American's snuff brands contributed $670 million, or 7.4 percent of revenue, last year. Some investors want further price increases on cigarettes, Adelman said. That could prompt more smokers to cut back or quit. The average retail price of a pack of Marlboros rose 3.1 percent to $3.68 in April from a year earlier, according to a Goldman Sachs report. Overall, the average retail price of a pack of cigarettes rose 4.7 percent to $3.64. U.S. shipments dropped 7 percent that month after prices advanced, Goldman Sachs said, citing a survey by Chicago-based researcher Information Resources Inc. The two types of Marlboro snuff being tested accounted for 6 percent of smokeless tobacco stocked by retailers, Altria estimated March 11. Smokeless tobacco has shown "remarkable progress," Szymanczyk told shareholders last month. 'Commercially Successful' "We've learned a lot that will allow us to efficiently develop our products further so we can have commercially successful products in these markets," he said. Marlboro, the best-selling cigarette brand, hasn't managed to achieve the same success with the Swedish-style snus, according to Adelman. UST's snus products also failed to win over U.S. smokers and traditional snuff users in about seven years of testing, CEO Murray Kessler said on April 24. The company, which controls 59 percent of U.S. smokeless- tobacco shipments, is reconsidering how much it will spend on snus, he said. "We've been very disappointed," Kessler said. To contact the reporter on this story: Chris Burritt in Greensboro, North Carolina, at cburritt@bloomberg.net. Enditem