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Reynolds Q3 Earnings, Rev Meet, Narrows Outlook

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Reynolds American Inc. delivered adjusted earnings of 86 cents per share in the third quarter of fiscal year 2013, in line with the Zacks Consensus Estimate. Earnings increased 8.9% from the prior-year quarter’s earnings of $0.79.

Adjusted earnings per share exclude a $0.02 impact due to charges for Engle Progeny lawsuits, other tobacco-related litigation, and implementation costs.

Earnings were on the upswing on the back of positive pricing in moist snuff and cigarette segment and lower Master Settlement Agreement (MSA) payment during the year.

The payment under MSA reduced as major tobacco players like Reynolds recently won a case against six of the fifteen U.S. states. The ruling stated that the tobacco players will not have to pay the six states for health-care costs.

Revenues and Operating Margin

Reynolds’ net sales in the reported quarter inched up 0.9% year over year to $2.14 billion. Market share gains of almost all the core brands like Camel, Pall Mall and Santa Fe aided sales growth during the quarter. Quarterly net sales were in line with the Zacks Consensus Estimate.

Adjusted operating income increased 5.8% to $808 million on the back of lower cost of sales. Adjusted operating margin inflated 1.7 percentage points (pp) to 37.8% during the period.

Segment Details

RJR Tobacco: Segment revenues declined 1.9% to $1.7 billion in the third quarter due to lower demand triggered by ongoing weak economy, high unemployment and a general shift of consumer preference toward smokeless tobacco products and e-cigarettes.

Volumes declined 4.3% in the segment due to losses on shipments. RJR Tobacco’s market share declined 0.5 pp year over year to 26.0% in the second quarter as market share gains in the two core brands of Camel and Pall Mall were offset by decline in other non core brands of the company.

Although volumes declined and tough industrial conditions prevailed, the company’s flagship brands of Camel and Pall Mall showed considerable strength and reported substantial market share gain during the quarter. While Camel’s market share increased by 0.4 pp to 8.9%, Pall Mall market share went up 0.3 pp to 8.9%.

Compared with the year-ago quarter, the segment’s adjusted operating income climbed 7.5% to $652 million, on the back of positive pricing and lower MSA cost. Adjusted operating margin inflated 3.3 pp to 37.5%.

American Snuff: Segment revenues climbed 6.2% to $185 million in the third quarter driven by volume growth and the market share gains

Volumes increased 7.1% in the quarter. The moist snuff market share increased 1.2 pp year over year to 33.4% in the quarter fuelled by modest gains of the Grizzly brand. Grizzly brand volumes shot up by 8.3% while market share expanded 1.6 pp to 30.4%. Grizzly brand benefited from strong demand of Grizzly’s pouch styles and wintergreen offerings.

Adjusted operating income increased 5.5% to $106 million, driven by higher moist snuff volume and positive pricing. Adjusted operating margin remained flat year over year at 57.0% backed by moist snuff volume gain.

Santa Fe:Segment revenues increased 28.0% to $160 million in the third quarter backed by higher volume.

Super premium brand Natural American Spirit’s volume inflated 21.7% and market share expanded 0.3 pp to 1.5%.

Adjusted operating income increased 29.4% to $82 million, driven by pricing and volume gains. Adjusted operating margin rose 0.5 pp to 51%.

Other Financial Update

Reynolds American spent $150 million to purchase 3.0 million shares under the company’s $1.9 billion share repurchase program.

In the quarter, Reynolds’ newly-formed subsidiary – RJ Reynolds Vapor Company – re-engineered and developed a patented vapor technology and a brand called Vuse brand under the e-cigarette category. Reynolds expanded the distribution of two varieties of the brand – Vuse Solo and Vuse System – in Colorado in July 2013.

In Sep, 2013, Reynolds commenced the public offering of senior notes worth $1.1 billion in two parts.

The first part of the notes offering, carrying an interest rate of 4.9% and scheduled to mature in 2023, will raise $550.0 million. The second part of senior notes worth $550.0 million, carrying an interest rate of 6.15%, will mature in 2043. In Oct, 2013 RAI entered into a new $1.4 billion revolving credit facility

Guidance Retained

Following the unimpressive third quarter results, Reynolds American lowered its fiscal 2013 adjusted earnings guidance to a range of $3.17 to 3.27 from previous expectation of $3.15 to $3.30 per share.

Reynolds carries a Zacks Rank #3 (Hold). Other diversified retailers worth considering include Constellation Brands Inc. (STZ - Free Report) , Nu Skin Enterprises Inc. (NUS - Free Report) and Altria Group Inc. (MO - Free Report) . While Constellation Brand and Nu Skin carry a Zacks Rank #1 (Strong Buy), Altria carries a Zacks Rank #2 (Buy).

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