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Reynolds Beats EPS, Sales Miss

Zacks Equity Research

Leading cigarette maker, Reynolds American Inc. (RAI) delivered adjusted earnings of 79 cents per share in the second quarter of fiscal year 2012 beating the Zacks Consensus Estimate by 3 cents. Earnings also increased 11.3% from the prior-year quarter as revenue decline was offset by margin growth.

Benefits from higher pricing, volume gains for moist snuff products and improved productivity offset decline in cigarette volumes to deliver the earnings beat in the quarter.

Revenues and Operating Margin

Reynolds’ net sales in the reported quarter declined 4.0% year over year to $2.18 billion due to declining cigarette volumes. Quarterly net sales also missed the Zacks Consensus Estimate of $2.26 billion.

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

Adjusted operating income increased 3% to $744 million while adjusted operating margin increased 2.4 percentage points to 34.2%. All the segments delivered positive operating growth in the quarter.

Segment Details

RJR Tobacco: This is Reynolds American’s largest operating segment comprising operations of R. J. Reynolds Tobacco Company, a subsidiary of Reynolds American. It includes popular cigarette brands like Camel, Winston, Kool, Doral, Salem and Pall Mall. Segment revenue declined 6.5% to $1.83 billion in the second quarter.

Volumes declined 6.7% in the segment compared to a 1.7% decline for the industry due to increased promotional activity by competitors. Declining consumer consumption and strict government regulations have been hurting cigarette volumes. RJR Tobacco’s market share declined 1.4% year over year to 26.2% in the second quarter. The premium Camel brand held a market share of 8.3% in the second quarter, down 0.1 percentage point. Value brand Pall Mall held a market share of 8.4%, down 0.2 percentage point as it faces stiff competition.

Compared with the year-ago quarter, the segment’s adjusted operating income improved 0.2% to $604 million, with premium mix, pricing gains and productivity benefits offsetting cigarette volume declines and increased promotional costs. Adjusted operating margin expanded 2.3 percentage points to 33.0%.

American Snuff: This segment comprises of operations of American Snuff Company, a wholly owned subsidiary of Reynolds American, and sells some of the largest selling moist snuff brands like Grizzly and Kodiak.Segment revenue increased 12.4% to $172 million in the second quarter.

Volumes increased 10.7% in the segment, double the 5% volume gain for the moist-snuff industry. American Snuff’s market share increased 1.7% year over year to 32.4% in the quarter. The Grizzly brand volumes grew 12.3% while market share expanded 2 percentage points to 29% benefiting from the company’s investment in retail contracts and its brand building programs. Grizzly is the best selling moist snuff brand in the U.S.

Adjusted operating income increased 18.4% to $95 million, driven by pricing and volume gains for the popular Grizzly brand. Adjusted operating margin increased 3.2 percentage point year over year to 55.4%. Profit margins on moist snuff products are generally higher than on cigarette products.

Santa Fe: This segment comprises of operations of Santa Fe Natural Tobacco Company, a wholly owned subsidiary of Reynolds American, which markets cigarettes as well as other tobacco products under the Natural American Spirit brand. Segment revenue increased 17.3% to $129 million in the second quarter.

Volumes increased 9.5% in the segment, a turnaround from the first quarter results due to an efficient supply chain. Natural American Spirit’s market share expanded 0.2 percentage points to 1.1%.

Adjusted operating income increased 25.9% to $64 million, driven by pricing and volume gains for its super premium brand Natural American Spirit. Adjusted operating margin increased 3.4 percentage point year over year to 49.4%.

Other Financial Update

In the quarter, Reynolds American increased its quarterly dividend rate by 5.4% to an annualized rate of $2.36 per share. It repurchased 6.1 million shares for $250 million in the quarter.


Following the solid second 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 $2.95 per share.

Competitor Altria Group, Inc. (MO) which also announced its second quarter results on the same day, beat on both the top and bottom line expectations.

Our Recommendation

We currently have a Neutral recommendation on Reynolds American. The stock carries a Zacks #3 Rank (a short-term ‘Hold’ rating) near term.

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