Altria (MO) is one of the largest tobacco companies in the U.S. with over 50% market share in cigarettes and smokeless product segments. The brand portfolio of Altria's tobacco operating companies includes well known names such as Marlboro, Copenhagen, Skoal and Black & Mild, and it markets premium wines sold under various labels including Chateau Ste. Michelle and Columbia Crest.

According to our estimates, more than 85% of the stock price is driven by cigarettes and smokeless products divisions of Altria.

Due to declining volumes in the cigarettes segment and increasing uncertainty over introduction of new products because of slow Food and Drug Administration reviews, we feel that the stock is overvalued at $33, which is around 10% above our price estimate.

Declining U.S. cigarette market

One of the trends we have factored into our price estimate is the declining market size of cigarettes in the U.S. The reasons for this include regulatory measures enforced by the FDA amid smokers moving to alternative nicotine products such as lozenges and e-cigarettes and growing health consciousness among the people. We forecast the market size of cigarettes in the U.S. to decline at an annual rate of around 1.5%-2% during our forecast period.

Slow FDA reviews causing uncertainty

Tobacco companies have introduced no new cigarettes or smokeless tobacco products in the U.S. in more than 18 months because the federal government has prevented them from doing so, an Associated Press review has found.

According to data obtained by the Associated Press, since June 2009, when the law allowing the agency to regulate tobacco went into effect, the tobacco industry has submitted nearly 3,500 product applications. While none have been ruled upon, a vast majority of these products are already being sold. Another clause in the law allows products similar to those already in the market as of February 2007 to be sold while under review. But 400 products submitted for review since then have been kept off the market.

Market for smokeless tobacco products

We have factored a 3% CAGR for smokeless tobacco products market in the U.S. However, delays in product approvals can potentially slow down the growth in this segment as well. Increased taxation is another risk associated with this segment as the smokeless tobacco products have been relatively spared by excise taxes (which are less than 7% compared to 32% on cigarettes). But this could change as the tobacco companies do not have sufficient scientific proof to claim that smokeless tobacco products are less harmful than cigarettes.

Overall, Altria's growth potential increasingly depends on product diversification as the U.S. tobacco industry's outlook seems uncertain. Industry revenues have been growing only marginally helped by raised prices since volumes are declining in the cigarettes market. Marketing restrictions, smoking bans, growing health awareness and tax hikes are all making the tobacco business tougher.