The tobacco industry has been facing challenges with growing its revenue and sales volume because of strict regulations, higher taxes, and rising consumer health awareness. Leading U.S. tobacco companies Lorillard (UNKNOWN:LO.DL), Altria (NYSE:MO), and Reynolds American (NYSE:RAI) have been experiencing sales volume declines in recent years, and have been relying on price increases to counter the aforementioned challenges. Aside from price increases, the companies are cutting their costs and undertaking share buybacks to fuel their earnings growth, which has brought them favorable results.
Lorillard has the third-highest volume share in the U.S. tobacco market at about 13%, following Altria and Reynolds at 53% and 27%, respectively. Lorillard has strengthened its brand portfolio in recent years by introducing Newport Red and Newport Gold. The company's total market share increased to 15.2% in the first quarter of 2014, up from 13% in 2010. Also, the company has a dominating market share of 40% in the menthol segment of the U.S. market.
The company's fundamentals remain strong and its solid market position provides the company with pricing power, which remains vital for revenue support. In the first quarter of 2014, the company increased its pricing by 6%, more than its 4.2% increase in 2013. Also, the company's sales volume performance outperformed the industry average. In the first quarter of 2014, the company reported adjusted volumes down 1.8%, in contrast to the industry's volume drop of 4%.
The company has potential to strengthen its market share and grow its earnings, given its solid brand portfolio. Analysts project a robust growth rate of 10.80% per annum for the next five years. However, the weak growth prospects of Newport Gold and incremental spending growth behind the e-cigs roll-out in the U.K. will likely put pressure on the company's earnings in the near term.
The company launched Newport Gold in the fourth quarter of 2014. The retail market share of Newport Gold has remained at about 0.30%, in contrast to analysts' market-share projection of 1%. The company needs to ramp up its promotional activities for Newport Gold to expand its market share. The increased promotional spending will, however, put pressure on the company's margins in the near term.
Lorillard continues to invest in e-cigs, as the sales volumes of traditional cigarettes are dropping; e-cigs have the potential to drive the next leg of growth for Lorillard and the tobacco industry. However, higher-than-expected spending by the company for the Blu e-cigs rollout in the U.K. will likely remain a drag on earnings for the next couple of quarters. Lorillard anticipates incremental spending of $10-$20 million for the Blu e-cigs rollout in the U.K.
Looking at the bigger picture
Altria, the leading U.S. tobacco company with a dominant market share of more than 50%, has price leadership in the market. The company has been consistently increasing its prices to offset the impact of a sales volume drop and support its revenue; Altria successfully managed to increase its cigarette pricing by 3.6% and about 4% year-over-year in the first quarter of 2014 and the full year of 2013, respectively.
Also, the company managed to outpace the volume performance of the industry in the first quarter of 2014, as its adjusted sales volume was down 3.5% in contrast to an industry volume drop of 4%. Also, Altria has been investing to grow its Mark-Ten (e-cigs) presence by increasing production, distribution, and brand-building efforts. In April, Altria acquired the e-vapor business Green Smoke for $130 million. Moreover, Altria has announced a nationwide launch for Mark-Ten in June. The aggressive and continued efforts will help Altria mark its presence in the e-cigs markets and positively affect earnings in the long term, but will also likely pressure near-term results.
Reynolds has also been pushing hard to increase the presence of VUSE (e-cigs) by expanding the product's distribution to Indiana and Wisconsin; it has already gained market-leading positions in Colorado and Utah. Also, Reynolds expects an additional 15,000 outlets to sell VUSE by the end of the ongoing second quarter. As VUSE is still in early stages of its rollout, the company has indicated that it remains flexible with its plans, given the capacity constraints.
However, the investments behind the roll-out of VUSE are likely to put pressure on the near term results of the company. Increased spending on VUSE resulted in a segment loss of $39 million in the first quarter of 2014, which could increase in upcoming quarters as the company plans to expand its distribution.
Lorillard's business fundamentals remain intact and its 'Newport' brand provides pricing power. The company has been consistently growing its market share in recent years with the help of product innovation and strategic initiatives. The company remains a market leader in the U.S. e-cigs market with a market share of 45%, which is likely to positively affect its earnings in the long term.
Also, the company has ramped up its efforts to expand the presence of its e-cigs in the U.K. market, which will strengthen the category in the long term; however, in the short term, the increased spending on the e-cigs roll-out is likely to put pressure on earnings in the short term.