Altria Group, Inc. (MO) Earnings Call Transcript

Good afternoon, everyone, and thank you for joining us. We're glad to be part of CAGNY once again this year, although we miss seeing you in person. Today, we'll discuss how we're moving beyond smoking and advancing our 10-year vision to responsibly transition adult smokers to a noncombustible future. Before we begin, we ask that you carefully review the safe harbor statement in today's presentation and the forward-looking and cautionary statements section in today's press release. These documents are available on altria.com, along with reconciliations and further explanations of the non-GAAP financial measures we discuss today. All references in today's remarks to tobacco consumers or consumers within a specific tobacco category or segment refer to existing adult tobacco consumers 21 years of age or older. 2020 was a challenging year as we, like many others, navigated through the pandemic, political and social unrest and an uncertain economic outlook. In that context, our employees and tobacco businesses demonstrated resilience, and we laid the groundwork for our noncombustible product portfolio to make significant progress toward our 10-year vision. The pursuit of our vision is about sustainability and businesses that are aligned with the responsibility expectations of our stakeholders. To better understand these expectations, we perform materiality assessments periodically to gather stakeholder perspectives on the most important environmental, social and governance issues that we must continue to address. Our latest assessment identified the following focus areas: protecting the environment, driving responsibility through our value chain, reducing harm of tobacco products, preventing underage use, supporting our people and our communities and engaging and leading responsibly. Leading in these areas isn't new for Altria and we continue to make significant progress across all 6 focus areas. Over the course of the year, we will update you on our ESG progress. And starting this month, our report on engaging and leading responsibly will include our 2025 goals established in these areas. We will now briefly highlight a few of the ESG areas where we raised the bar. We have a responsibility to minimize our environmental footprint and work to prevent the most damaging effects of climate change. Stakeholders' expectations have increased over the past few years, including the expectation for companies to set 2050 net-zero greenhouse gas emission targets. Later this year, we will assess our ability to establish this goal when the Science Based Targets initiative releases its methodology for companies to set credible net-zero targets. Currently, we have set ambitious targets to significantly reduce our greenhouse gas emissions by 2030. These targets were approved by the Science Based Targets initiative and represent a key step in our net-zero transition. We expect to continue our leadership by further aligning our reporting with recommendations from the Task Force on Climate-related Financial Disclosures. Supporting our people and our communities is another key focus area, and we're working to create a more inclusive and diverse organization. Inside Altria, we're breaking down implicit biases, creating more opportunities for employees and holding our leaders accountable for advancing inclusion and diversity. We continue to make progress against our inclusion and diversity aiming points for our senior leadership. Beginning this year, we will publish our Annual Consolidated EEO-1 report to be transparent about our progress. We have embedded IND considerations within our performance review process to hold our leaders accountable. For example, only those leaders who actively enhance the culture of inclusion and diversity in their organizations can earn our highest performance rating. In our communities, we have established a multiyear investment plan behind our commitment to addressing racial and economic inequities. For example, we are working with leading organizations that are advancing black-owned business development and criminal justice reform. The materiality assessment overwhelmingly affirmed that the most important social issues for our company to address are harm reduction and preventing underage use. For years, we've taken a comprehensive approach to underage tobacco use prevention and we continue to enhance our efforts. One of our newest initiatives includes monetary incentives to retailers for age validation technology. We expect this technology to be installed in over 120,000 stores by the end of 2021, which covers approximately 70% of PM USA cigarette volume. We are also investing in marketplace monitoring tools to gather more real-time data on underage usage trends to enable a faster response to potential issues. We are committed to continue our work with multiple stakeholders to drive down underage use and preserve the harm reduction opportunity that noncombustible tobacco products hold for smokers. Based on the regulatory framework in place and our deep understanding of U.S. tobacco consumer preferences and behaviors, we believe we can accelerate the pace of harm reduction over the next 10 years. Consumer dynamics support this belief and our opportunity. First, we believe tobacco product purchasers for consumers ages 21 through 39 look fundamentally different from older consumers, and we don't anticipate their preferences evolving into traditional tobacco categories. 33% of tobacco consumers aged 21 to 29 are exclusive noncombustible product users, the highest percentage of exclusive use across age cohorts. Second, we also believe it's critically important to understand consumer motivations behind their tobacco product selection. Based on our research, reduced social friction and reduced harm are important tobacco product features across many cohorts. Third, noncombustible tobacco products interest both male and female tobacco consumers. Although the specific purchase drivers vary by gender, ethnicity, socioeconomic status and age. Last and importantly, we also know that many consumers are open to using noncombustible products but have not found the right product to meet their needs. To address these opportunities, we are placing our unparalleled understanding of the tobacco consumer as the foundation of our efforts. Tobacco consumer insights and science will drive our noncombustible product development and regulatory engagement. And we believe we are well positioned with our leading sales and distribution capabilities to win in the market with our noncombustible products. We expect tobacco consumer preferences will continue to evolve, and we will use tobacco consumer insights to inform future market plans. As we announced in our fourth quarter results, we're making investments to enhance our tobacco consumer information. We have realigned internal resources to better support our vision. We've established 2 new departments that blend behavioral science, data insights and consumer engagement to support smoker conversion to noncombustible products. These functions will work with our strategy and marketplace insights group to develop noncombustible product conversion strategies, enhance our consumer communications and engagement and drive innovative product development planning and prioritization. We believe our enhanced infrastructure will lead to better conversion outcomes and more agile product development. Over the recent decades, we've built an adult tobacco consumer database and developed unique consumer connections through loyalty programs. We are enhancing these tools by working with our retail trade partners to increase the depth and breadth of point-of-sale purchase data. For example, today, we can follow purchasing behaviors to understand how individual smokers and dippers interact with on!. In these examples, we see varying pace and degrees of adoption across consumers from different categories and brands. Each consumer's journey will be different. And with deep analysis of this data, we will alter marketing approaches to better resonate with individual consumers, tailor consumer support and evolve products. We believe the tobacco consumer's understanding of the relative risk of noncombustible products compared to cigarettes is critical to achieving harm reduction. Peer-reviewed published studies on the relative harm from nicotine-containing products show a risk cliff or a profound risk differential between combustible and noncombustible product categories as a whole. We're advancing our leadership in the external environment through communications, engagement and science-based policy and regulatory solutions. We've recently established the position of Chief Scientific Officer to amplify our voice within the scientific and public health communities. Our Chief Scientific Officer will also lead our regulatory sciences team, which conducts the science necessary to support and expand our portfolio of noncombustible products. Research and insights on tobacco consumers allow us to prioritize our greatest new product opportunities. Our regulatory affairs team that applies a rigorous framework to evaluate potentially reduced harm tobacco products that considers several factors, including: a complete characterization of the product, reduced exposure and health risk for the individual and an assessment of the risk and benefits to the population as a whole. We continue to believe that no single product will satisfy all tobacco consumers. We're investing to build unique intellectual property and differentiated products across noncombustible categories. Let's now turn to our commercialization efforts for the compelling products we have today in oral and heated tobacco. In oral tobacco, we have an unmatched portfolio of moist smokeless tobacco and oral nicotine pouch products. Copenhagen remains the leading MST brand and on! is making excellent progress in the rapidly growing oral nicotine pouch category. on! is now available in over 78,000 stores which covers approximately 2/3 of total U.S. oral tobacco volume. By midyear 2021, Helix expects unconstrained manufacturing capacity for the U.S. market and plans to have on! available in stores covering 90% of oral tobacco volume and 80% of cigarette volume. Shipment volume for on! has steadily grown to keep pace with increased consumer demand and store expansion. on! achieved significant growth in the second half of the year and a retail share of 2.4% of the oral tobacco category for full year 2020 based on store selling and providing point-of-sale data. There are now approximately 1 million oral nicotine pouch consumers. Our data shows that on! continues to primarily source from smokers and dippers. And with enhanced distribution and in-store visibility, competitive oral nicotine pouch consumers are showing increasing interest in on!. We believe its unique packaging further differentiates on! from MST and competitive oral nicotine pouch products and has broader tobacco consumer appeal. Female smokers have been more engaged with oral nicotine pouches than with MST, making up approximately 25% of oral nicotine pouch consumers as opposed to 5%, respectively. We remain excited about the opportunity to continue to grow on! and its compelling product proposition. Let's turn now to heated tobacco where PM USA made significant progress in 2020. Working with our sales force, PM USA launched IQOS and Marlboro HeatSticks in Charlotte, introduced devices in select Charlotte convenience stores, developed creative digital tools to enhance consumer engagement and communicated with smokers using the FDA-authorized reduced exposure claim about the benefits of switching completely from cigarettes. HeatSticks grew across all markets in 2020. Following pandemic-related closures, growth trends resumed midyear as boutiques reopened and IQOS was launched in Charlotte. In stores with distribution, HeatSticks achieved a 9/10ths share of the cigarette category in both Atlanta and Charlotte markets in December. This share performance is encouraging, given strong cigarette volumes in these areas in 2020. We've seen consistent appeal of the IQOS proposition from competitive smokers. In fact, our experience to date indicates that nearly 40% of IQOS purchases are sourcing from competitive smokers. PM USA is evolving its plans based on learnings from the lead markets. Thus far, we have learned many smokers aren't aware of the full range of benefits of switching to the product from cigarettes. Smokers appreciate flexible engagement options, and some smokers are hesitant to purchase the product based on the initial purchase cost. Let's walk through these in turn and the actions PM USA is taking to address them. First, while many smokers are aware of the social benefits of IQOS and HeatSticks such as no ash and less odor, consumers have a low awareness of reduced exposure to harmful or potentially harmful chemicals when smokers completely switch from cigarettes. Last July, FDA authorized the communication of a reduced exposure claim with the IQOS 2.4 system, and PM USA quickly began to communicate the claim through its digital engagement platforms, direct mail, at boutiques and mobile retail. We believe smokers' understanding of the harm reduction benefits of noncombustible products relative to cigarettes will be an important factor in their decision to switch. Based on our research, approximately 40% of smokers would be interested in switching to our product based on an authorized reduced exposure claim. And PM USA plans to continue to strongly and responsibly reinforce this important message with smokers. Second, providing flexible options for smokers to engage with the product has been especially critical during the pandemic. Prior to boutiques closing in March 2020, more than half of device purchases were made from a boutique. As stores reopened in June, device purchases shifted primarily to mobile retail, accounting for nearly 2/3 of device purchases through the end of the year. These options allow smokers to engage with our team in convenient and socially distant settings. Further, PM USA developed online guided tutorials and mobile chat capabilities to support age-verified smokers in their IQOS journeys. And last, to address the initial purchase price concerns and encourage product trial, PM USA introduced more device purchasing bundles. In Charlotte, a 5-pack option and a new deluxe bundle provided choices for smokers to customize the package that best met their needs. PM USA also established a lending program for consumers to try the IQOS device for 2 weeks at a low introductory cost. Purchases from these bundle options and the lending program accounted for over 60% of Charlotte device sales in 2020, and the lending program has an impressive trial-to-purchase rate of 88%. Compared to the first several months of the Atlanta launch, the different marketing approaches in Charlotte resulted in nearly 3x the number of devices sold as a percentage of the smoker population. PM USA is expanding the availability of IQOS and Marlboro HeatSticks and continues to maximize the product's organic growth potential by focusing first on densely populated metro areas and then expanding outwards as the user base grows. Beginning in April, PM USA plans to expand HeatSticks and devices statewide within Georgia, Virginia, North Carolina and South Carolina. PM USA also plans to expand to the next metro market in Northern Virginia in the second quarter and open a boutique in Tysons Corner. This new market represents one of the highest populated metro areas in the U.S. Finally, PM USA plans to expand to 3 additional metro markets in the second half of 2021 and expects HeatSticks to be available in geographies covering approximately 25% of the U.S. cigarette volume by year-end. PM USA intends to maximize its first-mover advantage, while we're responsibly positioning the U.S. heated tobacco category for long-term growth and profitability. We're taking wide-ranging steps to lay the groundwork for Altria to move beyond smoking and make significant progress towards our vision. We're realigning our organization, expanding the availability and awareness of our portfolio of noncombustible products and investing in noncombustible product research and development. I'll now turn it over to Sal Mancuso, our Executive Vice President and CFO, to provide an update on our financial performance and capital allocation.

Thanks, Billy. While many investors have focused on cigarette volume trends, we believe it's important to step back and look at how the total tobacco space has evolved. When we equivalize volumes across categories, total domestic tobacco industry volumes declined 1% over the past 5 years on a compounded annual basis. With cigarette volumes declining over time, noncombustible categories, such as oral tobacco and e-vapor, have become a larger portion of the tobacco volumes, standing at approximately 22% in 2020. Last year marked a pause from historical trends as factors such as fiscal stimulus and stay-at-home practices significantly altered tobacco consumer behaviors. The smokable products segment continues to be the engine that powers our vision, generating significant cash that can be invested in noncombustible products and return to shareholders. Our smokable products strategy is to maximize the profitability of our combustible products while appropriately balancing investments in Marlboro, with funding growth of our noncombustible portfolio. The segment has delivered strong performance over a period of various cigarette industry volume decline rates, excise tax increases and smoker movement to other tobacco categories. In fact, over the last 5 years, our smokable segment grew adjusted OCI from $7.7 billion to $10.1 billion, representing a growth of 5.5% on a compounded annual basis. Marlboro continues to be the leading cigarette brand. And its relevance with smokers is supported by its leading consumer engagement platform across traditional and digital channels. In noncombustibles, the strategy of the oral tobacco products segment is to maximize profitability over time in traditional MST through the strength of Copenhagen and to responsibly and rapidly grow on! oral nicotine pouches. Since 2015, the segment grew adjusted OCI 9% on a compounded annual basis, expanded adjusted OCI margins by 7.6 percentage points to over 71% and maintain Copenhagen as the leading oral tobacco brand. In alcohol, our assets have served us well over time and provide us with diverse income streams. In beer, the company's original investment of $230 million in SABMiller in 1970 has now grown to an investment in the largest global beer company with a carrying value of $16.7 billion. As you may know, most of our ABI shares are currently restricted, with the lockup expiring in October of this year. We've recognized the importance of any future decisions related to our ABI stake. And we are conducting a thorough analysis to determine the best path forward for this investment. Turning to cannabis. We believe a federally legalized U.S. market presents a significant opportunity for adjacent long-term growth. The trend behind state legalization of cannabis continues to grow with medical use currently legalized in 36 states and recreational adult use legalized in 15 states. Further, cannabis legalization has strong support among the American public, with 68% of Americans supporting full federal legalization. In support of our investment in Cronos and as part of our investment governance, Altria is committed to working with policymakers and stakeholders to create a responsible and regulated legalized market in the U.S. We support a comprehensive federal regulatory framework that advances science, creates quality and safety standards, prevents underage use, and importantly, takes significant steps to address the historical impact of cannabis criminalization on communities of color. We believe that by working with policymakers and stakeholders who share this view, Altria can contribute in a meaningful way to advance efforts toward a legalized federal marketplace, and we're excited about the U.S. opportunity for our investment in Cronos. Turning to capital allocation. We remain focused on returning cash to shareholders and maintaining a strong balance sheet. Over the past 5 years, we've returned more than $33 billion in cash to shareholders through dividends and share repurchases. And we continue to maintain a long-term target dividend payout ratio of approximately 80% of adjusted diluted earnings per share. Last month, our Board of Directors authorized a new $2 billion share repurchase program that we expect to complete by June 30, 2022. Our balance sheet is strong and we're committed to maintaining an investment-grade credit rating and improving our credit metrics over time. As previously shared, we are executing a debt management transaction to take advantage of favorable market conditions, to adjust our debt maturity profile and extend the weighted average maturity of our debt. Finally, on guidance, we reaffirm our 2021 adjusted diluted EPS guidance of $4.49 to $4.62. This range represents a growth rate of 3% to 6% from a 2020 adjusted diluted EPS base of $4.36. I will now turn it back to Billy for closing remarks.

Thanks, Sal. Our journey as a responsible industry leader continues. We're building a best-in-class tobacco consumer insight system, with deeper and more actionable insights. We have an unmatched portfolio of noncombustible products in the U.S. market today and we're rapidly expanding. And we're investing in the science and technology to support the next generation of noncombustible products to meet consumers' needs. Our tobacco businesses have delivered strong performance over time and generate a significant amount of cash to invest in support of our vision and return to shareholders. And we believe we can continue to deliver significant value for our shareholders while moving beyond smoking. Thank you for your time and your interest in Altria.

Altria is moving in a new direction, from our legacy to leading the way forward, moving from smoking to potentially less harmful choices, and from being known as a tobacco company to being recognized as a tobacco harm reduction company. Moving beyond smoking. Altria.