Cig Business

With Reynolds American Inc. (RAI) due to release third quarter earnings on Tuesday, investors are holding their breath, waiting to see how the company’s pending antitrust inquiry and e-cigarette brand expansion will affect its bottom line.

RAI’s third quarter earnings are expected to reach $0.91 per share, a year-over-year increase of 6.5%, according to a consensus of analysts surveyed by Bloomberg. Quarterly revenue is expected to hit $2.2 billion, up from $2.1 billion in the third quarter of 2013.

RAI-- America’s second largest tobacco company and maker of Camel cigarettes-- is currently contending with an industry-wide decline in cigarette shipment volume. In September, CEO Susan Cameron predicted a decline of 4% in cigarette shipments across the tobacco industry for this year. RAI’s own shipment volume could be even worse, with a potential decline of 6%, according to research by financial services firm Cowen and Company.

Last quarter RAI’s shipment volume declined 4.4%-- although the company still beat analyst expectations, with $0.89 in earnings per share, and increased its net income for the third quarter in a row, totaling $492 million.

Despite flagging shipment volume, RAI stock has performed reasonably well in 2014. Shares of RAI have risen 18.7% since January, outperforming the S&P 500, which has risen 3% year-to-date. RAI has not quite kept pace with Altria Group, the top American tobacco company, which made gains of 20.5% so far this year.

Still, RAI’s stock has performed better than it did last year, increasing 15.1% from the same time one year ago. That’s mostly due to RAI’s proposed acquisition of Lorillard Inc., announced on July 15.

On tomorrow’s earnings call, investors will expect more information on the Lorillard deal’s progress. After the acquisition was officially announced, the Federal Trade Commission brought it under antitrust scrutiny at the end of August.

“On the call we’ll be looking to hear [whether] management will give further clarity on the progress of the pending acquisition,” wrote Vivien Azer, a consumer analyst at Cowen, in a third quarter earnings preview.

E-cigarettes will also be on investors’ minds tomorrow morning, as RAI expands its e-cig brand Vuse and works to make it profitable. In June, Vuse was released in 21,000 stores nationwide. In September, RAI expanded Vuse to 11,000 more stores across the country. Adding these new stores has given RAI a sizable boost in the e-cig market. Since the expansion, RAI more than doubled its e-cigarette sales, and secured the leading market share in the retail e-cig category for the first time, with a 29% dollar share.

RAI plans to make Vuse profitable by mid-2015. Analysts have expressed confidence that RAI is up to the task.

“We remain very bullish on vapor and expect re-acceleration of category growth once Vuse has a greater national presence,” wrote Bonnie Herzog, managing director tobacco research at Wells Fargo, in a report.

RAI's former headquarters will be added to the National Register of Historic Places and converted from offices to a hotel/apartment/restaurant. The project is expected to cost $60 million. It took years for RAI to find a buyer.

Linking out to an older article; this came out around the time the Reynolds American and Lorillard merger was announced. But it does a decent job of explaining what's desirable about Lorillard-- namely, its Newport brand. (And not blu e-cigs, as many guessed when the merger was announced.) Starting in the 1970s, Newport heavily marketed toward black smokers, and years of this targeted advertising are still paying off.  

Newport sales made up 12.2% of the total U.S. cigarette market in 2013, compared with 8.1% for each of Reynolds' top brands, Camel and Pall Mall, according to market research firm Euromonitor International.

Big Tobacco Merger is a Desperate Bid to Corner Black Smokers (Huffington Post)

US-centric businesses including RAI are poised to profit from global political unrest. Given the turbulence we're seeing-- military strikes against ISIS, protests in Hong Kong, a worsening Ebola epidemic-- some of the safest stocks investors can choose are those that do most of their business in the US. Same is true because the US dollar has been strengthening.

For Reynolds American Inc. (RAI), growth prospects look hazy. On the surface Reynolds-- the country’s second largest tobacco company and owner of Camel, Niconovum and VUSE e-cigarettes-- has had a big year, calling its former CEO Susan Cameron out of retirement to lead the company again, and a $27.4 billion merger with Lorillard Co. (LO).

But peeling back layers of the Lorillard deal, and assessing the threat of federal regulation looming on the horizon, it looks like Reynolds has a fraught road ahead. Although the announcement of the merger caused Reynolds’ stock to pop briefly, investors are uncertain that the Lorillard deal will be approved by the Federal Trade Commission. Piling on investor concern, Reynolds’ revenue has been stalled in recent years as American sentiment has turned against smoking, undermining Reynolds’ long-term growth.

Reynolds’ stock price was up 15% over the past year, not quite keeping pace with the S&P 500, which made gains of 16.7% (Reynolds’ P/E ratio of 19.86 is in line with the S&P, at 19.93). Meanwhile Altria Group Inc. (MO), the number one player in the industry, posted gains of 25% this year.

Altria still has the American cigarette market by the throat with its Marlboro brand, which constitutes 40% of American cigarette sales, according to the Centers for Disease Control and Prevention. With severe government restrictions on tobacco advertising, it can be difficult for a less dominant company like Reynolds to convert smokers to its brands. In light of these challenges, Reynolds’ revenue has fallen at a compound annual growth rate of about -0.8% since 2010.

The pending Lorillard deal, which is still under antitrust scrutiny by the FTC, could help a little. Most importantly, acquiring Lorillard means controlling Newport, the country’s second most popular cigarette brand with an 11.7% domestic market share. Newport is the leading brand of menthol cigarettes in the country, and it comes with an entrenched customer base.

“Compared to other brands, Newport’s got much more stable consumption. It’s got great brand loyalty,” said Philip Gorham, an analyst with Morningstar Inc. “It’s a phenomenal brand.”

On March 3, when rumors of a potential Lorillard merger gained steam, Reynolds’ trading volume and stock price both spiked. When the merger was officially announced July 15, Reynolds’ stock reached its highest price of the year, $63.18 per share, although it fell 1.2% the next day.

Just over a month later, the FTC requested additional information from both Lorillard and Reynolds to investigate whether the deal violated federal antitrust laws-- making investors jittery. Reynolds’ proposed cash-and-stock transaction with Lorillard is currently valued at $68.88 per Lorillard share, but Lorillard’s stock price has remained well below that, at $59.40.

“That tells me the market thinks there’s quite a significant chance the deal won’t close,” said Gorham. “People doubt that the deal will pass, because if Lorillard was going to be taken out in about six month’s time, why wouldn’t you buy the stock now and count on a return in six months? People are pricing in a risk that the deal doesn’t close.”

Plus, despite the hype over e-cigarettes, it’s unlikely they’ll come to Reynolds’ rescue revenue-wise, at least for now. In the proposed Lorillard merger, Reynolds divested Lorillard’s blu e-cigarette brand, the largest in the country, to Imperial Tobacco Group. Reynolds has its own e-cigarette brand, VUSE, which began a national expansion in June. Though the company bills VUSE as “the most technologically advanced and best-performing digital vapor cigarette on the market,” e-cigarettes have fared poorly in retail outlets in recent months. Over the past seven months, retail sales of e-cigarettes have declined; dollar sales of e-cigarettes fell by 7.5% in August, according to Nielsen’s convenience store data.

“There is consumer dissatisfaction with the product, which leads to high levels of rejection” said Vivian Azer, tobacco and beverages analyst at Cowen & Co., in Marketwach. “Consumers are willing to try the product, but they are not satisfied.”