Reynolds Shares Smoking On Newport, Tobacco''s Comeback

Source from:  Investor's Business Daily 03/31/2016

What a difference a brand can make.

Just ask big-tobacco company Reynolds American (RAI), now on a roll with its newly acquired Newport, the No. 2 cigarette in the U.S. behind Marlboro and the nation's No. 1 menthol brand. Even as tobacco consumption has fallen, Newport's market share has kept growing.

The gain was especially strong under Reynolds American's ownership in the fourth quarter, when U.S. market share for Newport among all brands grew to 13.6% from 13% a year earlier. Newport volume over that time grew 4.8%, while overall volume fell slightly.

"(Newport) has a strong and very loyal menthol franchise in the U.S.," Reynolds' Chief Financial Officer Andrew Gilchrist told Investor's Business Daily.

Winston-Salem, N.C.-based Reynolds has been stepping up sales and merchandising for Newport since its $26 billion acquisition last June of Lorillard Tobacco, which was the maker of Newport and other cigarette brands. The deal is often called the "Newport acquisition," and for good reason.

Reynolds hired new sales reps to talk up Newport to consumers and provided more shelf space and signage at retail locations such as gasoline station convenience stores, where many cigarettes are sold. Newport's strong growth comes as lower gas prices have helped stem declines in cigarette consumption.

As Gilchrist says, lower gas prices along with job and wage growth means smokers have more money to spend on cigarettes and for trading up to premium brands. Enter Newport and Reynolds' other premium brands, Camel and Natural American Spirit.

Noting that 2015 was a banner year for the U.S. tobacco industry, at least in an era of declining cigarette usage, Stifel Nicolaus analysts call the last 18 months the industry's new "Golden Age." They noted that somewhat higher than usual price increases last year helped boost profits.

While the Stifel analysts say 2016 may show less robust growth than 2015, they still see positive industry trends. Among them are light litigation and regulatory activity, modest excise tax increases, and "a core consumer that seems to be on the mend and improving again in 2016."

Reynolds American is the holding company for R.J. Reynolds Tobacco, the No. 2 U.S. tobacco company after Altria Group (MO), which makes Marlboro. Reynolds became a stronger No. 2 when it acquired No. 3 Lorillard. Its overall market share in the U.S. rose to 34% from 26%. Altria's remained at 51%. And since its acquisition of Lorillard on June 12, Reynolds' shares are up more than 40%.

Besides Newport, the Lorillard acquisition handed Reynolds the brands Kent, True and Old Gold. As part of the deal, Reynolds sold Winston, Kool, Salem and Maverick to Imperial Tobacco Group, or ITG, the American arm of UK-based Imperial Brands. ITG is now No. 3 in the U.S., with a market share of 9.5%.

Besides Camel and fast-growing Natural American Spirit, which is under Reynolds' Santa Fe natural tobacco unit, Reynolds makes the value brand Pall Mall and leading e-cigarette brand Vuse.

"The Newport brand should continue to benefit from improved visibility across Reynolds' retail footprint as well as its inclusion in Reynolds' retail contracts," wrote Morgan Stanley analyst Matthew Grainger in a recent report.

"Moreover," he added, "Newport has been realizing broad-based share gains across both menthol and non-menthol styles, which should drive its long-term growth potential."

Wells Fargo analyst Bonnie Herzog notes that Newport is "poised for greater than expected share gains and faster growth," which should strengthen the company's long-term profitability.

In a recent tobacco survey by Wells Fargo, retailers expected Newport to gain 95 basis points of incremental share in 2016, up from an expected 80 basis points when they were queried in early December.

One retailer in the survey said, "RJR gained major power with Newport. It's really a two-horse race now."

In Q4, Camel's retail market share was 8%, the same as a year earlier, while Pall Mall's was down 0.3 percentage points to 7.8%, though the value brand had been stable over the last three quarters. Newport, Camel and Pall Mall make up about 92% of Reynolds' total market share and are considered core growth, or "drive" brands.

Reynolds doesn't disclose sales for its Vuse digital vapor products. But though Gilchrist says growth was significant in 2015, sales are still relatively small and aren't broken out. That segment logged only $98 million of the $3.05 billion in total revenue in Q4, up from $87 million a year earlier.

Reynolds has new vapor products in the works and a vapor collaboration is underway with stakeholder British American Tobacco ( BTI) to help grow the market.

British American owns 42% of Reynolds' shares. Analysts speculate that it may try to buy the remaining 58% stake, but are divided on when that may happen, if ever.

Since 1999, when it sold international businesses such as its Camel and Winston franchises to Japan Tobacco, Reynolds sells essentially all of its products in the U.S. It recently sold Natural American Spirit's business outside the U.S. for $5 billion, money it's using to deleverage its balance sheet.

Reynolds American also operates Niconovum, which distributes nicotine-replacement gum Zonnic; and American Snuff. The latter is the second-largest maker of smokeless tobacco products, selling under the Grizzly and Kodiak brands.

But Newport is the company's big star. In Q4, Reynolds' domestic cigarette volumes jumped 33.6% over the prior year, driven by the addition of Newport. Industry cigarette volume fell 0.5% during the quarter and 0.1% for the full year, Reynolds said, lower than the usual declines seen in recent years.

The firm's adjusted earnings in Q4 grew 9.1% to 48 cents a share. Revenue was up 43% to $3.05 billion. Management expects profits this year to rise between 13.6% and 18.7%, which translates to earnings of $2.25 to $2.35 a share. Analysts see this year's revenue rising 19% and earnings going up 18%, according to a Thomson Reuters poll.

In a post-earnings conference call on Feb. 11, Chief Executive Susan Cameron said the quarter's strong performance "was largely the result of Newport's growth."

Newport was added to the company's retail contracts in mid-November after a post-acquisition standstill period. The brand's expanded presence "is delivering additional gains," she said.

Meanwhile, expected cost savings will come as Reynolds continues to integrate Lorillard into the fold. Some $500 million of the $800 million expected in savings was achieved on day one of the acquisition, much of it in duplicate infrastructure.

The remaining $300 million in synergies by year-end "is a bit ahead of schedule," said the company's Gilchrist. Enditem