Reynolds American Inc.’s (RAI) adjusted earnings of 89 cents per share in the second quarter of fiscal 2014 beat the Zacks Consensus Estimate of 87 cents by 2.3%. Earnings also surpassed the prior-year quarter results by 6%, backed by higher cigarette and moist snuff pricing which, more than offset increased investment on the Vuse brand of e-cigarettes.
Adjusted earnings per share exclude a 3-cent impact due to charges for the Engle Progeny lawsuits, other tobacco-related litigation and Non Participating Manufacturer (NPM) Partial Settlement with two additional states.
Revenues and Operating Margin
Reynolds’ net sales slipped 0.8% year over year to $2.22 billion due to lower sales in the tobacco segment. Quarterly net sales marginally missed the Zacks Consensus Estimate of $2.23 million.
Adjusted operating income went up 2.6% to $474 million due to higher pricing of moist snuff and cigarettes. Adjusted operating margin shrank 0.8 percentage points (pp) to 37.4% during the period.
Segment Details
RJR Tobacco: Segment revenues slipped 3.1% to $1.73 billion in the quarter. The decline can be attributed to lower demand triggered by the ongoing economic weakness, high unemployment and a general shift of consumer preference toward smokeless tobacco products and e-cigarettes.
Volumes declined 6.8% in the segment due to shift of demand to smoke-free alternatives. RJR Tobacco’s market share declined 0.1 pp year over year to 26.5% in the second quarter due to a decline in market share in non-core brands
Although volumes declined and tough industrial conditions prevailed, the Camel and Pall Mall brands reported substantial market share gain during the quarter. While Camel’s market share increased 0.4 pp to 10.2%, Pall Mall’s market share went up 0.1 pp to 9.3%.
Compared with the year-ago quarter, the segment’s adjusted operating income climbed 2.3% to $1.25 billion, as higher pricing offset higher marketing expenses. Adjusted operating margin shrank 3.3 pp to 40.2%.
American Snuff: Segment revenues inched up 0.5% year over year to $195 million in the second quarter driven by volume growth and market share gains.
Volumes decreased 0.5%year over year in the quarter mainly due to lower wholesale inventories. The moist snuff market share increased 0.5 pp year over year to 34.4% fueled by modest gains of the Grizzly brand. Grizzly brand’s market share increased 0.7 pp year over yearto 31.4%. The brand benefited from strong demand for Grizzly’s pouch styles and Wintergreen offerings.
Adjusted operating income increased 0.1% year over year to $110 million, driven by higher moist snuff volume and positive pricing. Adjusted operating margin remained flat year over year at 56.3%.
Santa Fe: Segment revenues increased 13.5% year over year to $168 million in the quarter backed by higher volume.
The segment’s super premium brand Natural American Spirit’s volume inflated 7.9% year over year, and market share went up 0.2 pp year over yearto 1.6%.
Adjusted operating income increased 15.1% year over yearto $84 million, driven by pricing and volume gains. Adjusted operating margin inflated 0.4 pp year over yearto 49.6%.
Other Financial Update
Reynolds American spent $267 million to purchase 4.8 million shares during the quarter. The company also completed its $2.5 billion share repurchase program started in Nov 2011
Reynolds announced that it has entered into an agreement to take over rival Lorillard Inc. (LO) for $68.88 per share or $27.4 billion, including assumption of net debt. Investors are, however, of the opinion that Reynolds is paying far too much for the company. Investment bank Lazard Ltd. (LAZ) will act as a financial advisor in the takeover process.
The combined entity might pose a threat to its peer Altria Group Inc. (MO), which manufactures Marlboro cigarettes and commands more than 40% market share in the U.S.
Reynolds began the first phase of expanding the distribution of its newly launched electronic cigarette Vuse nationwide in the quarter. The next phase is scheduled to start in Sep 2014.
Guidance Tightened
Reynolds American, which currently carries a Zacks Rank #2 (Buy), tightened its fiscal 2014 guidance. The company expects earnings in the range of $3.35 to $3.45 compared with $3.30 to $3.45 expected earlier. The guidance reflects an increase of 5.0% to 8.2% from fiscal 2013 earnings of $3.19. The company expects to increase its investment in its newly launched e-cigarette brand Vuse in fiscal 2014.
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