Altria Group was valued using various methods including free cash flow valuation and discounted cash flow analysis. Free cash flows were projected for 2014-2019 using a 5% revenue growth rate and 1.5% terminal growth rate, resulting in a valuation of $67.64 per share. The weighted average cost of capital was calculated to be 7.32% using a cost of equity of 7.83% and cost of debt of 5.83%. Relative valuation compared Altria's return on assets of 14.71% and return on equity of 168.21% to competitors.

1. FIN 4274: Equity Securities: Analysis and Management
Professor Billingsley: MW 2:30
April 20th, 2015
Written By:
Justin Wooldridge
Brian Fioravante
Charles Cornett
Catherine Wilson
Jake Seraphin
Wenhui Lin
Table of Contents
I. Porters 5 Forces:

2. A. Threat of New Entry
B. Buyer Power
C. Threat of Substitution
D. Supplier Power
E. Competitive Rivalry
II. SWOT Analysis:
A. Strengths
B. Weaknesses
C. Opportunities
D. Threats
III. Comprehensive Financial Statement Analysis:
A. FCF Valuation
B. WACC
C. Discounted Cash Flow Model
D. Comparable Sheet
1. Relative Valuation
2. Multiple Valuation
3. Dupont ROE Analysis Equity Valuation
E. Analysis of Excess Earning
IV. Analysis of Results and Conclusion
V. References
VI. Appendices
Porters Five Forces: Tobacco Industry

3. Threat of New Entry:
Tobacco companies have low threat of new entry because of high barriers to entry
through high required capital expenditure, competition with large established brands, and
competing with the high economies of scale currently in use by existing firms. Entrance into the
tobacco industry requires a very large investment in factories and machinery to make tobacco
products. Furthermore, the competitive environment that exists in the tobacco industry consists
of few companies that make the majority of all tobacco products used. These companies already
have huge market shares and loyal customers through their well known brands. In addition,
existing companies in the industry obtained high economies of scale through years of operations
and expansions, and it would be hard for a new company to compete with the large established
companies. The threat of new entry in the tobacco industry is low for the short and long term
because it would be very expensive and difficult to break into and obtain market share in the
industry.
Buyer Power:
Buyer power of customers is low for the tobacco industry. The industry is highly
regulated and taxed which has led to high prices for tobacco products. In addition, the major
tobacco brands has established very loyal customer bases that will pay any price to obtain their
favorite products. Also, the nicotine in tobacco is highly addictive, and once customers become
regular users it is very hard for them to stop buying tobacco products, no matter the cost. Overall,
the tobacco industry faces low buyer power because it consists of very loyal customers and an
addictive product that allow companies to command high prices for their products.
Threat of Substitutes:

4. The threat of substitutes is low for the tobacco industry due to the unique effects
customers experience when using tobacco products. Customers enjoy the euphoric feeling from
using tobacco products, and there aren’t any similar products that can offer the same effect that
are easily obtainable or legal. While there is no direct substitute for tobacco products, customers
may choose to quit tobacco by substituting it with other products including: nicotine
supplements, sunflower seeds, and chewing gum. Furthermore, the culture in the United States is
shifting to healthier lifestyles which could hurt the tobacco industry. To hedge against this risk,
tobacco firms are investing in new technologies, such as electronic cigarettes, to make using
tobacco less harmful to the health of users. Overall, the threat of substitutes for tobacco is low;
however, the possibility exists of customers ceasing to use tobacco products because of health
and other concerns.
Supplier Power:
The power of suppliers within the tobacco industry is considered to be a low power
threat. A low power threat of suppliers occurs when there are many suppliers for an industry or
the demand for supplies is less than the supplier’s capacity to satisfy all demand. The materials
required for tobacco manufacturing include various types of paper, cellulose fibers, and a variety
of additives. However, the most important raw material used by tobacco manufacturing
companies is tobacco leaves, which are purchased directly through tobacco farmers or at auction.
Globally, the number of tobacco suppliers exceeds demand causing some countries to enforce
contracts to purchase domestically. For example in America, Congress passed a domestic content
law that required manufacturers to use at least 75 percent domestic leaf in U.S.-manufactured
cigarettes. That law was found to be inconsistent with the General Agreement on Tariffs and

5. Trade and the domestic content law was replaced with a tariff rate quota, which assesses a 350-
percent duty on imports beyond a fixed quota.
Competitive Rivalry:
Within the tobacco industry, the overall threat of rivalry is high considering there are
only a few companies that serve this market. The three leading players are Altria, Reynolds and
Lorillard. Having such a small amount of players makes for intense rivalry because competitors
are constantly seeking ways to reach a competitive advantage over one another to gain market
share. Companies, such as Altria, have used mergers and acquisitions as a tool to improve their
market position. Furthermore overseas expansion offers attractive growth due to rising income
levels and less regulation and added scale allows these corporations to better withstand
competition from small discounters at the retail level. The pursuit for an advantage over
competitors can lead to businesses changing their prices of their products or increasing the
amount of capital for product innovation, both of which have a negative effect on profits. In
addition to only having a few competitors within the industry there are also a significant amount
of brands and products available to consumers resulting in an increase in competition.
SWOT Analysis:
Strengths Weaknesses

6. ● Largest tobacco manufacturer in
the U.S.
● Strong market position with high
bargaining power
● Purchasing power and product
innovations
● Declining domestic cigarette volume
sales by 3-5% per year since 2012
● Reliance on cigarettes as major source
of revenue
Opportunities Threats
● Growth in International markets
● Development of Electric Cigarette
technology
● UST acquisition allowed entry into
smokeless tobacco market
● Increased government regulations
● Rising Federal and State Excise Taxes
● Growing awareness of health and
social consequences
Strengths:
Altria is the largest U.S. tobacco company and accounts for 50.6% of total U.S. cigarette
sales (as of 2013). It’s leading focus brand is Marlboro, which attributes to the highest volume
of cigarettes sold in the world. The Marlboro brand gives Altria a high bargaining power
because not only are cigarettes addictive, but the consumers in this industry stay loyal to their
brand. Altria also has a high purchasing power and that can be seen through the growth they
have sustained through acquisitions and new product innovations. In 2007, Altria acquired John
Middleton Inc., a leading manufacturer of machine-made cigars for $2.9 Billion and then in
2009, Altria acquired UST,Inc which is the largest U.S manufacturer of smokeless tobacco

7. products for $11.7 Billion. Their newest product innovation in 2007 of the Marlboro Menthol has
been driving domestic gains. These acquisitions and new technologies show that Altria has been
a dominant force in this industry and is liking to continue to control the market for tobacco.
Weaknesses:
The biggest issue in the tobacco industry is that cigarette sales have been been steadily
declining 3-5% per year since 2012. This is most likely due to increases in cigarette prices,
growing health and societal concerns, new government regulations, and anti-smoking and
tobacco campaigns (tobacco companies are required to fund these campaigns). Altria also relies
on cigarette sales for more than three quarters of their revenues indicating their need of
diversification. This puts future revenues at risk if the new societal trend moves away from the
conventional cigarette. Altria is trying to prevent lower revenues by moving into the smokeless
market domestically and internationally.
Opportunities:
Altria has a vision to grow internationally, and they have the resources and capabilities to
do so. With global cigarette volume sales increasing by 7% between 2001 and 2013, Altria is
trying to take control of that market. Nearly 80% of the world’s smokers live in low- and
middle-income countries and with Altria already having the highest domestic share, their goal is
to target these emerging international markets. Their idea was to dominate internationally due to
the fact that most foreign countries had less strict government laws and regulations than the U.S.
They recently signed a cross-licensing agreement with their former subsidiary, Philip Morris
International, to commercialize it’s e-cigarette brand internationally. In regards to the Electric
Cigarette, Altria has been innovating through the development of this new technology. They are
hoping to market to consumers who have health and social concerns with smoking. Regular

8. cigarettes contain chemicals and these chemicals burn with the tobacco which emits an odor,
whereas electric cigarettes are odorless and only contain tobacco. The acquisition of UST has
also given Altria access to the smokeless market. Some of the smokeless products such as
Copenhagen, Skoal, and Marlboro Snus (MST) have been extremely profitable in Europe and
Altria has hopes that their popularity can spread to the United States and other parts of the world.
Altria is in a solid position to grow due to their resources, domestic and global market share, and
recent innovations and acquisitions.
Threats:
For quite sometime now, tobacco companies have been subject to many regulations by
the FDA and they have been steadily increasing. In June 2009 President Obama signed the
Family Smoking Prevention and Control Act, which gives the FDA the authority to regulate the
manufacture, distribution, and marketing of all tobacco products. This law, among other things,
ended Altria’s ability to introduce new products without oversight, ushering in a new era where
tobacco products are subject to public health-based regulation. In addition to the Family
Smoking Prevention and Control Act, in 2010 the FDA mandated that manufacturers could no
longer produce cigarettes or cigarette tobacco with a characterizing flavor other than tobacco or
menthol. If the regulations and policies implemented by the FDA continue to tighten then it
could lead to a substantial increase in the cost associated with Altria’s products. Along with
increasing regulations, the government taxes have also been increasing. On April 1, 2009, the
largest federal cigarette excise tax increase in history went into effect, bringing the combined
federal and average state excise tax for cigarettes to $2.21 per pack. This increase in tax will
likely cause many consumers to possibly quit smoking or find a substitute for cigarettes. To put

9. this into perspective, the CDC reported that a 10% increase in the real price of cigarettes is
estimated to reduce consumption by nearly 4%.
Another major threat to this industry is the growing awareness of health concerns of
tobacco. The U.S. has been trending toward a health-aware society and the societal view of
smoking is shifting to being “socially unacceptable”. The only advertisements related to tobacco
are all about the negative effects of it. Smoking in some public areas (restaurants) has been
banned due to health issues caused through second-hand smoke. Altria has tried to salvage this
shift by developing Electric Cigarettes for safer smoking and smokeless tobacco to avoid odors
caused by smoking.
Comprehensive Financial Statement Analysis
Altria Group (MO) was valued using a variety of absolute methods applicable to a
number of sectors, including FCFF, FCFE, and WACC. In addition, several relative valuation
techniques were used, including the EBITDA multiple and ROE/ROA analysis, that reflected the
firm’s position in comparison to their main competitors.
Free Cash Flows:
2013 2014 2015 2016 2017 2018 2019 Terminal Value

10. Revenue 25748100 27035505 28387280.25 29806644 31296976 537748736.7
COGS 15448860 16221303 17032368.15 17883986 18778185 319900952.1
Gross Profit 10299240 10814202 11354912.1 11922657 12518790 217847784.6
Operating Exp. 2574810 2703550 2838728.025 2980664 3129697 53316825.34
EBIT 8,582,000 7724430 8110651 8516184.075 8941993 9389092 164530959.3
Less: TAX -2703330 -2703550 -2838728 -2980664 -3129697 -3286182 -55982666.61
Add: NCEXP 208000 257481 270355 283872.8 298066.4 312969.7 5331682.534
Less: NCREV 0 0 0 0 0 0 0
Less: ΔRC -146000 -257481 -270355 -283872.8 -298066.4 -312969.7 -5331682.534
Less: ΔNWC -2000 -2040 -2080.8 -2122.41 -2164.86 -2208.16 -37617.74457
Less: CAPEX -163000 -171150 -179707.5 -188692.87 -198127.5 -208033.8 -3544018.649
Equals: FCFF 5,865,670 4,847,689.5 5,090,135 5,344,704.3 5,612,003 5,892,668 104,966,656.30
PV of FCF 5,865,670 4,514,938.5 4,415,332 4,317,922.3 4,222,660 4,129,498 104,966,656.30
sum of
PV
(x1000) 132,432,678 # of shares 1,957,884,615 price $67.64
For our free cash flow analysis, several factors were taken into account when determining
the assumptions for the growth rate. The historical growth of the company’s revenues was one
aspect, but external factors such as the overall decline in cigarette sales and other
economic/political market forces impacted our forecasting. Recent history suggests positive yet
modest growth, appropriate for such a mature firm while declining sales volumes for the sector

11. suggest limited future growth potential. We decided on a five percent growth rate for the
forecasted years of 2015-2019, a figure more in line with the company’s historical growth. A
terminal growth rate of 1.5 percent was chosen based on the somewhat bleak outlook of the
sector and Altria’s limited prospects moving forward. Cost of goods sold was determined as 60%
of revenue based on historical figures. Operating expenses was projected as 10% of revenue
based on historical calculations. The terminal rates are the same for the both of these
components, as it was believed that such a mature firm had already obtained any possible
operating efficiencies. Depreciation was set at a constant one percent of revenue based on the
historical financials. The change in net working capital was the most difficult value to assume
and is the biggest concern regarding the reliability of our valuation. Change in net working
capital for 2014 was $2,000,000. However, in previous years Altria had incurred huge negative
changes in its net working capital as they incurred current liabilities largely in excess of current
assets, excluding cash. It didn’t seem sustainable for Altria to consistently divest in net working
capital, so for our forecasts we simply indexed the $2,000,000 change for 2014 for inflation and
carried that two percent rate to its terminal value. In all of the historical financials we sorted
through we could never find any spike in CAPEX. Thus, we assumed that internally Altria
already had “smoothed out” the “lumpy” CAPEX and growing the normalized value based on
the historical trend would be appropriate. However, if we were incorrect in our assumption, that
would have led to an understatement of CAPEX and hence an overvaluation of the cash flows.
Altria’s calculated average effective tax rate was thirty five percent. This value was applied for
the forecasted years and terminal value. Once the FCF was determined for all forecasted years
and terminally, the present value of these values was taken, discounted at the WACC (calculated

12. below). These discounted free cash flows were then summed, and divided by the number of
Altria’s outstanding shares to determine our valuation of the share price.
WACC:
To find the WACC we first found cost of equity. To find the cost of equity, we used the
return of Altria, which we calculated using the growth rate of five year dividends and the current
dividend yield, and the ten year treasury bond rate of 1.9% as well as the market beta of 0.79 to
calculate the cost of equity of 7.83%. Next, we calculated the cost of debt. We used a table of
bonds and their coupon rates that we found on MorningStar to calculate the average interest on
the bonds which gave us the cost of debt 5.83%. We then plugged in these figures into the
WACC equation to find the weighted average cost of capital of 7.32%.
Altria Group Inc. R.J. Industry

13. Reynolds
Relative Valuation
ROA 14.71% 9.67% N/A
ROE 168.21% 32.51% N/A
Operating PM% 44.00% 32.00% 33.00%
Beta 0.78 0.80 1.00
Multiples Valuation
P/E 20.24 27.19 22.16
P/S 5.71 4.66 4.66
EBITDA Multiple 14.43 15.99 N/A
Relative Valuation:
The metric we chose to use to value margins was the operating profit margin percentage.
Altria has a operating profit margin of 44% while the industry average is 33% along with their
comparable, Reynolds, who has an operating profit margin of 32%. Altria’s operating profit is
about 11% larger than the average, meaning Altria is substantially outperforming the market
which is highly attractive to investors. The substantial difference between Altria’s profit margin
and the industries could be attributed to effective cost controls through good management
practice.
Next we compared Altria’s Return on Assets and Return on Equity to the largest
competitor, Reynolds, and the industry as a whole. ROA gives us an idea as to how efficient

14. management is using its assets to generate earnings. After calculation we found that Altria has a
ROA of 14.47%, which is about 4.5% percent higher than their largest competitor. Further more
Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company
(or more specifically, its management team) is managing the equity that shareholders have
contributed to the company. With that being said Altria is substantially outperforming their
competitors with a 168% return on equity, which is more than 5 times the ROE of their
competitors. ROE is one of the most important metrics for evaluating management effectiveness
and in Altria’s case, it seems that their management has made decisions that positively affect the
company and in turn please the investors.
Multiple Valuation:
To value Altria we used the price to earnings multiple ratio, price to sales multiple ratio,
and the EBITDA multiple. Altria had a P/E ratio of 20.24, a P/S ratio of 5.71, and an EBITDA
multiple of 14.44; Reynolds, Altria’s main competitor, had a P/E ratio of 27.19, a P/S ratio of
4.66, and an EBITDA multiple of 15.99. The P/E ratio of Altria compared to Reynolds shows
that Altria’s price per share of stock is lower than Reynolds based on earnings. When comparing
both company’s P/E ratio to the industry average of 22.16, it shows that Altria is undervalued by
the market and Reynolds is overvalued. However, looking at the P/S ratio for both companies
shows that Altria’s ratio of 5.71 is higher than both Reynolds, 4.66, and the industry average,
4.66. This means that based on sales that Altria’s stock price is slightly overvalued when
compared to its competitor and the industry.
The last multiple used to value Altria was the EBITDA multiple. This is found by
dividing the enterprise value of the firm by its EBITDA. This is considered a reliable way to
value a company when compared to a accurately comparable company. When valuing Altria

15. based on Reynolds EBITDA multiple of 15.99, a price per share of $65.91 is found. This is
significantly higher than the price of 51.75 that Altria is currently trading at, and means that,
based on the EBITDA multiple valuation, Altria is being undervalued by the market.
Analysis of Excess Earning:
We using excess earning valuation because the it adjust the valuation for the present
value of the difference between the company’s free cash flow and earning as long as we using
clean-surplus accounting and the excess earning method is algebraically equivalent. When we
decide the excess earning of Altria, we determine the initial investment capital value and use the
WACC to calculate the firm value which is basic framework of excess earning value. We found
that the different between the free cash flows and the excess earning is equal to the initial
invested capital
Analysis of Results and Conclusion:
The tools we used for our valuation methods helped us evaluate Altria’s performance
individually, as well as a look at how they compare to the tobacco industry and some of their
competitors in that industry. We considered internal and external factors related to Altria and to
their industry in our analysis, and determined Porter’s Five Forces and a SWOT analysis would
be good tools. The key takeaways we found were that Altria has a dominating market share and
in the past has taken advantage growth opportunities through innovation and by expanding
internationally. Also, the tobacco industry has a high competitive rivalry in terms of Porter’s
Five Forces, but the rest of forces pose minimal threat.
The valuation methods that included financial calculations to analyze Altria’s
performance were Free Cash Flow, Weighted Average Cost of Capital, and Relative and
Multiple Valuations. From these we concluded that Altria was undervalued in it’s industry. The

16. current stock price sits slightly above $50 per share, but the Discounted Free Cash Flow Method
of valuing the stock price indicated it should be around $68 per share. We also used the
EDITDA multiple of 15.99 that we found through their main competitor, Reynolds American
Inc., and determined the stock price found through this method would value Altria at about $66
per share. In terms of relative valuations, some of the items we compared were the Return on
Assets, Return on Equity, and Operating Profit Margin Percentages of Altria, Reynolds
American Inc., and the entire tobacco industry. Altria has an operating profit margin that is 11%
higher than the tobacco industry and their main competitor, while maintaining a slightly higher
Return on Assets. The Return on Equity, however, is above 100% and is about 5 fives more than
Reynolds American Inc., indicating they greatly outperform their competitors.
Our valuation says that the tobacco industry is undervalued, however we feel there are
external factors that lead us to believe that Altria will not be able to maintain a competitive
advantage. These external factors may also explain the current discrepancy in pricing between
the market and our valuation. In recent news there have been rumors indicating a likely merger
between Altria’s top two competitors, Reynolds and Lorillard. Assuming these two companies
will divest the necessary assets and/or brands to make this merger possible (avoiding antitrust
concerns), the combined firm will then have the same amount of market share as Altria. We also
believe the new government regulations and a change in the outlook of tobacco by the public
also jeopardizes this undervaluation. New government regulations have increased the taxes on
tobacco, put restrictions on the public areas people can smoke in, and tobacco products are now
subject to health based policies. Along with laws regulating tobacco, the public is becoming
more and more aware of the negative effects and health concerns related to tobacco. Smoking is
now being viewed as “socially unacceptable”. The financial valuation methods did indicate

17. Altria was undervalued, but we still believe the non-financial factors are more important in this
case in determining future performance.
References:
-https://www.etrade.wallst.com/v1/common/pdf.asp?docKey=72-02209S10-
231DA6KAB7RFCFK940KJ5F4K7J&ComponentType=&User_SessionID=52F74F12A12E63
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http://www.forbes.com/sites/greatspeculations/2014/06/03/altria-set-to-pose-a-stiff-challenge-to-
existing-e-cigarette-leaders/
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tm
http://finance.yahoo.com/q;_ylc=X1MDMjE0MjQ3ODk0OARfcgMyBGZyA3VoM19maW5hb
mNlX3dlYgRmcjIDc2EtZ3AEZ3ByaWQDBG5fZ3BzAzEwBG9yaWdpbgNmaW5hbmNlLnlha
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high-look-out-below

18. http://seekingalpha.com/article/2870196-u-s-tobacco-industry-suffers-slow-death-altria-trading-
at-premium-despite-major-headwinds
https://finance.yahoo.com/q/ae?s=MO+Analyst+Estimates
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