Leading cigarette maker Reynolds American Inc. (RAI - Analyst Report) delivered adjusted earnings of 84 cents per share in the second quarter of fiscal year 2013 that were ahead of Zacks Consensus Estimate of 83 cents by a penny. Earnings were up 6.3% from the prior-year quarter.
Adjusted earnings per share exclude a 2 cents impact 2013 Master Settlement Agreement (MSA) payment, 1 cent charge related to implementation costs and 1 cent charge related to tobacco litigations.
Earnings were on the upswing on the back of positive pricing in moist snuff and cigarette segment and higher profit in RJR Tobacco, American Snuff and Santa Fe segments.
Revenues and Operating Margin
Reynolds’ net sales in the reported quarter inched up 0.1% year over year to $2.2 billion backed by solid market share gains by the key brands of the company. Quarterly net sales, however, were in line with the Zacks Consensus Estimate.
Adjusted operating income increased 7.5% to $800 million on the back of strict cost controls. Adjusted operating margin inflated 2.4 percentage points to 36.6% during the period.
RJR Tobacco: This is Reynolds’ largest operating segment, comprising operations of R. J. Reynolds Tobacco Company, a subsidiary of Reynolds American and the second-largest U.S. tobacco firm. It includes popular cigarette brands like Camel, Winston, Kool, Doral, Salem and Pall Mall.
Segment revenue declined 2.2% to $1.8 billion in the second quarter due to lower demand triggered by ongoing weak economy, high unemployment and a general shift of consumer preference towards smokeless tobacco products and e cigarettes.
Volumes declined 6.0% in the segment due to losses on shipments. RJR Tobacco’s market share declined 0.3 percentage points year over year to 26.0% in the second quarter.
Despite tough industrial conditions, the company’s flagship brands of Camel and Pall Mall showed considerable strength and reported higher year over year market share.
Compared with the year-ago quarter, the segment’s adjusted operating income climbed 9.8% to $662 million, on the back of positive pricing. Adjusted operating margin inflated 3.9 percentage points to 36.9%.
American Snuff: This segment comprises operations of American Snuff Company, a wholly-owned subsidiary of Reynolds American and the nation’s second-largest manufacturer of smokeless tobacco products. It sells some of the largest selling moist snuff brands like Grizzly and Kodiak. Segment revenue soared 12.7% to $194 million in the second quarter backed by higher gains in moist volume.
Volumes increased 9.4% in the segment from the prior-year quarter. The moist snuff market share increased 0.7 percentage point year-over-year to 33.1% in the quarter fuelled by modest gains of the grizzly brand. Grizzly brand volumes shot up by 10.6% while market share expanded 1.0 percentage points to 30.0%, benefiting from the higher share in the pouch market.
Adjusted operating income increased 15.3% to $109 million, driven by volume and market share gains for the popular Grizzly brand. Adjusted operating margin increased 1.1 pp year over year to 56.5% backed by moist snuff volume gain.
Santa Fe : This segment comprises operations of Santa Fe Natural Tobacco Company, a wholly-owned subsidiary of Reynolds American and manufactures Natural American Spirit cigarettes and other additive-free tobacco products. Segment revenue increased 14.7% to $148 million in the second quarter backed by higher volume.
Super premium brand Natural American Spirit’s volume inflated 14.6% and market share expanded 0.3 pp to 1.4%.
Adjusted operating income increased 14.0% to $73 million, driven by pricing and volume gains for its Natural American Spirit. Adjusted operating margin remained flat year-over-year at 49.2%.
Other Financial Update
Reynolds American exited the second quarter with a cash and cash equivalent of $1.7 billion, compared with $2.8 billion in the prior quarter.
Long term debt in the quarter remained flat at $5.02 billion sequentially.
Reynolds American spent $150 million to purchase 3.1 million shares under the company’s $1.8 billion share repurchase program.
During the quarter, RAI’s newly formed subsidiary – RJ Reynolds Vapor Company – has re-engineered and developed a patented vapor technology and a brand called Vuse brand in the e-cigarette category. RAI launched the brand in two varieties – Vuse Solo and Vuse System – in Colorado in Jun 2013.
Following the second quarter results, Reynolds American reaffirmed its fiscal 2013 adjusted earnings guidance in the range of $3.15 to $3.30 per share. The guidance reflects strong momentum of the operations of all the segments of the company. The Zacks Consensus Estimate stands at $3.23 per share.
The regulatory watchdog Food and Drug Administration is expected to put a ban on the menthol flavored cigarettes as it has noted that it is more lucrative to starters because of its smooth and cool taste. Hence it will trigger a rise in smoking population in the nation. This is expected to affect RAI’s sales negatively in the coming quarters.
Reynolds carries a Zacks Rank #3 (Hold). Other diversified retailers worth considering include Flower Foods Inc. (FLO - Snapshot Report), Lorillard Inc. and Tyson Foods Inc. (TSN - Analyst Report) all carrying a Zacks Rank #2 (Buy).