Reynolds' 3Q EPS In Line, Sales Lag

Leading cigarette maker, Reynolds American Inc. (RAI - Analyst Report) delivered adjusted earnings of 79 cents (excluding a one-time charge of 5 cents) per share in the third quarter of fiscal year 2012, up 6.8% from the prior-year quarter earnings of 74 cents.

Benefits from improved pricing and volume gains for moist snuff products offset decline in cigarette volumes and marketing expenses. The results were in-line with the Zacks Consensus Estimate.

Revenues and Operating Margin

Reynolds’ net sales in the reported quarter declined 3.8% year over year to $2.12 billion due to declining cigarette volumes. Quarterly net sales also missed the Zacks Consensus Estimate of $2.19 billion.

Governmental actions that prohibit the use of tobacco products, along with diminishing social acceptance of smoking, are adversely impacting Reynolds’ volume.

Adjusted operating income increased 1.7% to $764 million while adjusted operating margin increased 2.0 percentage points to 36.1%.

Segment Details

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 company. It includes popular cigarette brands like Camel, Winston, Kool, Doral, Salem and Pall Mall. Segment revenue declined 6.1% to $1.77 billion in the third quarter.

Volumes declined 6.9% in the segment compared to a 2.7% decline for the industry due to losses on shipments and increased promotional activity by competitors. RJR Tobacco’s market share declined 1.0% year over year to 26.4% in the third quarter.

The premium Camel brand held a market share of 8.5% in the third quarter, almost flat year over year. However, it is pressurized by a weak economy and promotional activity by competitors. Value brand Pall Mall held a market share of 8.7%, up 0.1 percentage point.

Compared with the year-ago quarter, the segment’s adjusted operating income declined 3.9% to $606 million, with cigarette volume declines and increased promotional costs more than offsetting pricing gains and productivity benefits. Adjusted operating margin expanded 0.7 percentage points to 34.2%.

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 increased 6.7% to $174 million in the third quarter.

Volumes increased 6.6% in the segment compared to the 5% volume gain for the moist-snuff industry. The moist snuff market share increased 0.9 percentage points year over year to 32.2% in the quarter. Grizzly brand volumes grew 7.8% while market share expanded 1.2 percentage points to 28.8% benefiting from the company’s investment in brand building programs. Grizzly is the best selling moist snuff brand in the U.S.

Adjusted operating income increased 11.4% to $100 million, driven by volume and market share gains for the popular Grizzly brand. Adjusted operating margin increased 2.4 percentage points year over year to 57.4%. Profit margins on moist snuff products are generally higher than on cigarette products.

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 $125 million in the third quarter.

Volumes increased 13.9% in the segment. Natural American Spirit’s market share expanded 0.2 percentage points to 1.2%.

Adjusted operating income increased 35.3% to $63 million, driven by pricing and volume gains for its super premium brand Natural American Spirit. Adjusted operating margin increased 7.4 percentage point year over year to 50.4%.

Other Financial Update

In the quarter, Reynolds American repurchased 6.5 million shares for $300 million in the third quarter.

Guidance

Following the third quarter results, Reynolds American reaffirmed its fiscal 2012 adjusted earnings guidance in the range of $2.91 to $3.01 per share. The Zacks Consensus Estimate stands at $2.96 per share.

Competitor Philip Morris International Inc (PM - Analyst Report), which reported its third quarter results on October 18, beat the bottom line expectations. However, it lagged the top-line expectations.

Currently, the stock carries a Zacks #4 Rank (a short-term Sell rating). We have a Neutral recommendation on Reynolds American over the long term.