Reynolds American's (NYSE:RAI) latest conference call hints at a brighter future for U.S. tobacco companies. While many challenges remain, the company is primed for a better year ahead as it counters cigarette volume declines and grows its e-cigarette business. Here's what Reynolds American's management team wants you to know about its progress. All quotes are taken from the Oct. 12 conference call with analysts.
Core business catching fire
President and Chief Executive Officer Susan Cameron has good news to report:
For some time now, our strategy has been to strengthen the operational performance and profitability of our core cigarette and moist snuff businesses. As you can see from today's report, these efforts are really paying off.Earnings and margin are up across the Board and our companies' key brand remained a powerful force in the competitive marketplace.
Better volume and higher pricing combined for solid earnings growth in the third quarter. Adjusted EPS for Q3 was $0.95, up 10.5% from the year-ago quarter. Management shifted its focus to Camel and Pall Mall -- the two core brands that it will retain after its planned merger with Lorillard -- resulting in higher market share for both brands. The company recently changed Pall Mall's packaging, giving it an enhanced look and feel to emphasize its premium quality.
Reynolds American's snuff brands are also performing well, with its flagship Grizzly brand increasing its market share to 31.1% in the third quarter, up 0.1 percentage point from the year-ago quarter.
These brands' strong performance contributed to 10.5% earnings per share growth. The stock is up more than 10% since the quarter's results were reported. .
With regards to the company's investments in new business lines, Cameron says:
Our companies are also building for the long term and that means investing in platforms for sustainable growth in an evolving environment as part of our strategy to transform the tobacco industry. This too is paying off. ... VUSE production capacity is still being ramped up and I would remind everyone that the company will continue to make substantial investments on VUSE in the fourth quarter in line with the brand’s expansion.
Since Lorillard's blu e-cigarette brand will be jettisoned when the merger is completed, Reynolds American is counting on its Vuse to capture a large share of the emerging e-vapor market. Already available in nearly 70,000 retail outlets, Vuse's distribution will be further expanded in the early part of 2015. The brand will require further investment to increase production capacity, though management has not yet specified how much additional investment will be necessary to complete Vuse's nationwide rollout. However, Cameron expects that Vuse will be profitable by the middle of 2015, thus creating a tailwind for earnings growth.
Cameron also talked about the national expansion of Niconovum USA's ZONNIC nicotine gum
Though the market remains skeptical that regulators will allow it, Cameron says Reynolds American will close on its acquisition of Lorillard during the first-half of 2015: "I remain confident that we will reach a successful closure of the transaction in the first half of next year and transition planning is well underway."
Cameron insists that the merger preparations are progressing smoothly and that nothing unexpected has emerged in talks with regulators. This bodes well for those shareholders who think a combined Reynolds American and Lorillard would carry significant advantages for both companies.
Stemming the decline
Cameron also delivered good news on cigarette volume: "The decline in cigarette volumes moderated during the third quarter."
The moderation in the cigarette volume rate of decline is terrific news for all U.S. tobacco companies. Reynolds American's volume declined 2.9% in the quarter and industry volume declined just 2.7%. The company's core cigarette brands -- Camel and Pall Mall -- performed even better: Pall Mall volume decreased 1.5% and Camel volume increased 3%. Management expects industry volume to decline 3.5% for the year, a significant improvement from last year's 4.6% decline.
Not only is cigarette volume moderating, but it is doing so while prices are rising: "Higher pricing was a significant factor [in strong earnings results]."
Reynolds American recently announced its second price hike this year, $0.07 a pack, according to the Winston-Salem Journal. Flattening volume despite higher prices could be a sign that most of the price-sensitive smokers have already left the brands. If that's the case, then Reynolds American may be able to raise prices even faster than usual in the quarters ahead.
On track to hit guidance
"As a result of this successful performance and with a clear eye on what's in store for the rest of 2014, I am pleased to say that we are on track to meet our earnings guidance for the full year," said Cameron.
Management has guided for $3.35 to $3.45 adjusted earnings per share for fiscal 2014, which translates to 5% to 8.2% growth year over year. If cigarette volume continues to flatten and Vuse becomes meaningfully profitable, earnings per share could grow even faster in 2015.
Ted Cooper has no position in any stocks mentioned. 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.