Why You Should Buy Reynolds American Today

Reynolds American's first-quarter results show the company's strengths.

May 7, 2014 at 6:19PM

All of the big tobacco companies have reported first-quarter results during the past few weeks, and Reynolds American's (NYSE:RAI) results gave investors plenty of reasons to celebrate. First off, Reynolds' headline sales figures ticked up 2.8% year over year, mainly as a result of price increases, as the volume of cigarettes shipped by Reynolds decreased by 3.8% year over year.

That being said, the company's growth brands, specifically, Camel and Pall Mall, actually reported a year-over-year rise in volumes of cigarettes shipped by 1.2%, although these gains were offset by a 13% slump in the volume of other cigarettes sold by the company. Nevertheless, when combined, these two growth brands account for two thirds of Reynolds' total cigarette shipment volume.

Not just cigarettes
Elsewhere, Reynolds' smokeless snuff and moist-snuff sales performed well, with overall sales rising 10.7%. In addition, the company's subsidiary, Santa Fe Natural Tobacco Company, reported a 10.7% jump in sales of cigarettes sold.

As a subsidiary, Santa Fe's cigarette sales are not consolidated into Reynolds' total cigarette sales volumes. Santa Fe Natural Tobacco Company manufactures and markets Natural American Spirit 100% additive-free natural tobacco products, including styles made with organic tobacco. Natural American Spirit's market share is 1.5%, and the brand is an undiscounted premium brand with an operating margin of 48.3% and a loyal adult consumer base.

Confusing figures
Having said all of that, one thing that may confuse shareholders is Reynolds' reported EPS, which slumped 27.2% year over year. This reduction in profit is due to a charge of $69 million relating to Engle progeny lawsuits, and $4 million of implementation costs. Unfortunately for tobacco companies, lawsuits are unavoidable, so although reported as a one off, there are likely to be similar legal charges levied against Reynolds in the future.

Still, what's important is Reynolds' underlying earnings, as these show the true health of the business. Underlying adjusted EPS were reported at $0.72 for the first quarter, unchanged year over year. Along with the results, Reynolds' management reaffirmed 2014 adjusted EPS guidance to fall within the range of $3.30 to $3.45, up 3.5% to 8.2% from 2013's adjusted EPS of $3.19.

The industry is outperforming
These results from Reynolds follow an impressive set of first-quarter results from larger peer, Altria (NYSE:MO), and together, both sets of results show that the tobacco industry is still very much one of the markets better-performing sectors.

Excluding the effect of special items, Altria's first-quarter EPS ticked higher by 5.6% year over year to $0.57. Altria's management also narrowed 2014 EPS forecasts from $2.51 to $2.58 up to $2.53 to $2.60 -- implying growth of at least 6% for the year.

Like Reynolds, Altria also reported a decline in the number of cigarettes shipped; the volume of Marlboros shipped slid 2.4% for the quarter. Altria's revenue from smokeless products jumped 6.4%, and smokeless operating income increased 7.7%.

Altria's smokeable-products revenue declined 0.2%, but due to an operating margin improvement of 2.2%, the company's operating income from smokeable products jumped by 6.4%. Ste. Michelle, Altria's wine subsidiary, reported strong growth, with sales jumping 2.4% year over year; a 1.2% increase in margin meant that operating income from wine increased by 10%.

Foolish summary
To sum up, both Reynolds and Altria recently reported an impressive set of first-quarter figures and, while these two companies are selling fewer cigarettes, profits continue to expand. Indeed, these figures show that tobacco companies remain solid investments, and one of the few industries that can still grow profits while sales volumes decline.

All in all, Altria and Reynolds are two strong, well-run companies, and both make great investments.

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Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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