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What I Learned From Reading Altria Group Inc (MO)’s Annual Report

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“Other guys read Playboy. I read annual reports.”

— Warren Buffett

I’m not quite as fanatical as Warren, but I do enjoy digging into a company’s annual report to learn something new. Especially for companies I own.

Over the next few weeks I’ll be reading the 10-Ks of all the companies I own shares in, first page to the last. This week: Altria Group Inc (NYSE:MO).

Here are five things I learned from Altria’s annual report (which you can read here).

1. Cigarettes: Revenue flat, earnings up.
Altria Group Inc (NYSE:MO)The big risk Altria Group Inc (NYSE:MO) investors face is a decline in cigarette consumption, which has been ongoing for decades. Part of the decline in cigarette volume is made up for through higher sales prices. But Altria has also boosted margins thanks to lower costs. Operating margins in the cigarette segment have grown nicely over the last three years:

Smokable products

Year Revenue Operating income Operating margin
2010 $22.2 billion $5.6 billion 25%
2011 $21.9 billion $5.7 billion 26%
2012 $22.2 billion $6.2 billion 28%

This can’t go on indefinitely. But it helps explain why the company has fared so well even with a declining customer base.

2. Excise taxes outweigh profits.
State and federal governments spend more than $1 trillion a year on health care, so it’s not surprising that they try to recoup part of the cost of high medical bills by taxing unhealthy products. Over the last three years, the excise taxes Altria Group Inc (NYSE:MO) has paid on cigarette sales far outweigh the company’s profits:

Year Operating income Excise taxes
2010 $5.6 billion $7.3 billion
2011 $5.7 billion $7.1 billion
2012 $6.2 billion $7 billion

A recent study on cigarette taxes by the Congressional Budget Office writes:

A 1 percent rise in the price of cigarettes results in roughly a 0.3 percent decline in the number of smokers. The total reduction in cigarette consumption from such a price increase is significantly greater than 0.3 percent, according to past research, because it reflects both the decrease in the number of people who smoke and a decrease in the average number of cigarettes consumed by people who continue to smoke.

3. Volume among Altria’s big brand is falling faster than I thought.
Cigarette volumes are falling slowly — that much I knew. But the decline at Altria Group Inc (NYSE:MO)’s flagship Marlboro brand is pretty severe. Total volume is being held up by better performance of the company’s discount brands:

Shipment volume (sticks, in millions)

Brands 2012 2011 2010
Marlboro 116,377 117,201 121,893
Other premium 8,629 9,381 10,315
Discount 9,868 8,556 8,630
Total cigarettes 134,874 135,138 140,838

Altria Group Inc (NYSE:MO) writes:

The willingness of adult consumers to purchase premium consumer product brands depends in part on economic conditions. In periods of economic uncertainty, adult consumers may purchase more discount brands and/or, in the case of tobacco products, consider lower-priced tobacco products.

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