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Can Reynolds American (RAI) Surprise This Earnings Season?

Zacks Equity Research

Reynolds American Inc. (RAI) is set to report second-quarter 2014 results on Jul 29, before the opening bell. Last quarter, the company posted a negative surprise of 2.7%. Let’s see how things are shaping up for this announcement.

Factors to Consider This Quarter

Reynolds has been witnessing lower-than-expected volumes recently due to a general shift away from tobacco products amid accelerating prices of cigarettes and worldwide anti-tobacco campaigns. Moreover, high investment in the national rollout of Reynolds’ newly launched e-cigarette brand Vuse is putting pressure on the margins.

An unfavorable pricing war among tobacco makers amid higher taxes levied by governments across the world are also limiting the pricing power of Reynolds. We believe these headwinds will persist in the second quarter.

However, Reynolds' product innovations and cost reduction initiatives have helped it to tide over the difficult economic conditions. Moreover, the company is expected to witness better top-line results in the quarter backed by revenues from Vuse which was launched nationwide in Jun 2014.

Management is also confident about the company’s resilient fundamentals and expects fiscal 2014 earnings to increase 3.5% to 8.2% year over year. The guidance takes into account significant investment in Vuse, as well as additional investments in the equity building efforts on the key brands.

On July 15, 2014, Reynolds announced that it has entered into an agreement to take over rival Lorillard for $68.88 per share or a total consideration of $27.4 billion, including assumption of net debt. Investors are not happy with the deal as they feel Reynolds is paying too much for the company.

Earnings Whispers?

Our proven model does not conclusively show that Reynolds is likely to beat earnings this quarter. A stock needs to have both a positive Earnings ESP and a Zacks Rank #1, 2 or 3 to surpass earnings estimate. However, that is not the case here due to the following factors:

Zacks ESP: ESP for Reynolds is 0.00%.

Zacks Rank: Reynolds has a Zacks Rank #2 (Buy) which when combined with a 0.00% ESP makes surprise prediction difficult.

We caution against stocks with Zacks Rank #4 and 5 (Sell-rated stocks) going into the earnings announcement, especially when the company is seeing negative estimate revisions momentum.

Other Stocks to Consider

Here are some other consumer staples companies that investors may want to consider as our model shows that they have the right combination of elements to post an earnings beat this quarter:

Treehouse Foods Inc. (THS), with an Earnings ESP of +1.21% and a Zacks Rank #1 (Strong Buy).

Colgate-Palmolive Co. (CL), with an Earnings ESP of +1.37% and a Zacks Rank #2.

The J. M. Smucker Company (SJM), with an Earnings ESP of +1.46% and a Zacks Rank #3 (Hold).

Read the Full Research Report on RAI
Read the Full Research Report on CL
Read the Full Research Report on SJM
Read the Full Research Report on THS


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