Reynolds American (NYSE:RAI) reported results this week that were all-around uninspiring. Top- and bottom-line sales were close to analysts' expectations, and management narrowed its guidance by shaving a few cents off the top end and bumping up an equal share on the bottom. The company's core brands are showing mediocre gains, while the super-premium and other tobacco products buoy the business. The most interesting element to Reynolds' business is the prospect of vapor nicotine delivery -- e-cigarettes. Depending on how the smoke clears in the regulatory environment, e-cigarettes could give Reynolds (and the rest of big tobacco) the boost it needs.
Net sales inched up less than 1%, while bottom-line adjusted earnings grew a more appealing 8.9% to $0.86 per share. As mentioned above, both levels came in roughly in line with the Street's estimates. The bottom line benefited more than sales due to favorable pricing in both cigarettes and snuff, along with a lower-than-expected legal settlement in several states.
Broken down by segment, RJR Tobacco (the company's core brands) saw revenues decline 1.9% based on demand, American Snuff grew 6.2% on the back of demand and market share gains, and the super-premium Natural American Spirit brand grew volume by an impressive 21%. Operating income for that segment grew slightly less than 30%.
Shares didn't move too far, as investors and analysts didn't find much reason to celebrate the stock. The domestic tobacco market faces the difficult long-term trend of declining demand, but the company can benefit from the lightning-fast rise of vaporized nicotine. The question is how much it can get moving before federal and state regulators clamp down.
E-cigarette marketing and promotion is in the anything-goes stage that big tobacco enjoyed decades ago with its core products. Turn on the TV, and you can find celebrities endorsing the smokeless nicotine delivery systems, while there hasn't been a cigarette ad on the air for 40 years.
Regulators are working to address the issue, but in the meantime it's an area where big tobacco can capitalize in a big way. With the exception of some states, the tobacco-free products can be purchased without proof of age, because they haven't yet come under regulation by the Food and Drug Administration.
The e-cigarette market is young and growing at an incredible rate. The products are set to replace 1.5 billion traditional cigarettes this year, and some estimates say it's a $10 billion market by 2017.
Reynolds formed a new branch, R.J. Reynolds Vapor, to sell the company's Vuse products. The company is launching a television advertisement in Colorado. The ad tells viewers it's the "perfect puff, first time, every time." For investors, this is the area to focus on, and one that will certainly show up on future income statements.
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