Reynolds Benefiting from Uptick in Cigarette Purchases

Source from:  Winston-Salem Journal 10/27/2015

Lower energy and gas prices continue to be a ripple-effect boom for traditional cigarette manufacturers, particularly Reynolds American Inc., a leading industry analyst said Monday.

Wells Fargo Securities analyst Bonnie Herzog said in her third-quarter earnings preview that "the overall combustible cigarette environment continues to remain robust," primarily because of a combination of "lower gas prices, a stronger tobacco consumer, higher pricing and lower promotional spending.

Reynolds announces its third-quarter earnings today, followed by Altria Group Inc. on Thursday.

"We expect both companies will report low-mid double-digit earnings per share growth given the continued strong industry trends," Herzog said. "We remain very bullish on the U.S. tobacco sector and believe the stars remain aligned for the industry."

However, Herzog warned that ITG Brands of Greensboro, the U.S. subsidiary of Imperial Tobacco Group Plc, continues to struggle with gaining traction with the four traditional cigarette brands - Kool, Maverick, Salem and Winston - Imperial acquired in June for $7.1 billion. ITG Brands' revenue will be included in Imperial's third-quarter report of Nov. 3.

Herzog describes the uptick in smokers' interest in traditional cigarettes as a "renaissance" - a term decried by anti-tobacco and anti-smoking advocates since it reflects the potential to reverse the recent trend of declining adult and youth smoking rates.

The number of adult Americans who smoke hit a historic low of 15.2 percent during the first quarter, the Centers for Disease Control and Prevention said in September.

That's down from 17.8 percent in 2013, 20.9 percent in 2005 and 24.7 percent in 1997.

In April, the CDC said traditional cigarette smoking rates among high schoolers dropped to a low of 9.2 percent in 2014.

Herzog said another factor may be "moderating vapor category growth with several consumers being disillusioned by e-cigs, switching back to combustible cigarettes," Herzog said.

Herzog focuses on e-cigs, also known as ciga-likes, that are sold primarily in convenience stores, rather than vaporizers, which are mostly sold in tobacco and vapor shops and have been harder to track for revenue and usage data.

"It again highlights that stepped-up innovation is critical for the long-term success of this category," Herzog said.

Herzog said Reynolds's $29.25 billion deal for Lorillard Inc, essentially to acquire top-selling menthol brand Newport, is benefiting the manufacturer even before it introduces new line extensions, stepped-up advertising and a strong promotional push.

Herzog said Reynolds is projected to benefit from the Nov. 16 ending of its agreement to adjust its every-day-low-price program temporarily to give Imperial time to promote the four brands on retail shelves.

The program is a voluntary retailer contract that Herzog said has a 60 percent participation rate currently. Retailers that elect to participate must agree that Pall Mall is the lowest-priced cigarette in their stores. Retailers receive greater promotional allowances across many of Reynolds' brands, including Camel and soon Newport.

"This should enable Reynolds to more tightly control/manage its growth brand-pricing structure, as well as gain incremental space for Newport, which could ultimately drive greater market share, profitability and accelerated growth for Newport, as well as the entire portfolio," Herzog said.

Herzog projects Philip Morris USA's Marlboro brand will be bolstered by the debut of Marlboro Midnight, a menthol aimed at a younger adult demographic.

Herzog said that "more than 50 percent of retailers believe ITG will lose cigarette share, primarily due to lack of focus given too many brands and Reynolds' and Altria's position of power," Herzog said.

"However, ITG is expected to get aggressive with promos on its recently acquired brands, specifically Winston.

"Further, the bulk of our contacts predict an uphill battle for blu eCigs to succeed under its new ownership." Enditem