Reynolds American Looks to Keep Its Momentum

Image: Reynolds American.

For a long time, Reynolds American (RAI +0.00%) has labored in the shadows as the No. 2 tobacco producer in the U.S., and the company's merger with former competitor Lorillard wasn't quite big enough to change that industry dynamic. Nevertheless, Reynolds American has taken strides to try to improve its competitive position, and coming into its third-quarter financial report on Tuesday, Reynolds investors hope that the tobacco company will be able to build on its earlier success and keep reaping big benefits from the Lorillard merger. Let's take an early look at what's been happening with Reynolds American and what investors should look for to be certain that it will keep making progress.

Stats on Reynolds American

Source: Yahoo! Finance.

Can Reynolds American earnings keep climbing higher?
In recent months, investors have been increasingly upbeat about the prospects for Reynolds American earnings, raising their third-quarter estimates by a penny per share and boosting full-year 2015 and 2016 projections by roughly 2% to 3%. The stock has also fared quite well, climbing more than 23% since late July.

Reynolds American's second-quarter financial report in August showed the strength that the post-merger company has already enjoyed. Sales jumped 11% despite the fact that Lorillard's results were only included in Reynolds American's consolidated numbers for three weeks of the quarter, and adjusted net income rose at an even faster 22% clip. Early signs showed that the integration of Lorillard's Newport brand into the Reynolds American lineup had a substantial impact on the overall company's results, and it stands to outpace traditional high-sales Reynolds brands like Camel going forward.

Yet Lorillard isn't the only thing that has been going right for Reynolds American, and the newly combined company is aiming to take advantage of all of its opportunities. The company's Santa Fe Natural Tobacco subsidiary has had great success in marketing the ultra-premium brand Natural American Spirit, with the company's use of organic tobacco matching well with consumers' increased consciousness of high-quality farming practices throughout the agricultural industry. Natural American Spirit has been able to command higher prices for its product, and that's a trend that Reynolds will watch closely.

Yet Reynolds American has also made it clear that it sees the U.S. market as its most important source of potential success, choosing not to move in the direction of Philip Morris International (PM +0.97%) and instead making alternative arrangements to maximize the value of its brand assets. In October, Reynolds announced that it had sold the rights to sell Natural American Spirit outside the U.S. to Japan Tobacco, choosing not to pursue the opportunity itself and therefore not taking on Philip Morris International on its own turf. The deal will put $5 billion into Reynolds American's coffers, and that should help the company pay down some of the debt it took on its buying Lorillard and make its balance sheet more secure.

Investors have also celebrated a favorable result in litigation with the State of New York that will have a sizable impact on future earnings. By settling claims related to the state's treatment of some of the company's competitors in handling payments under a master settlement agreement, Reynolds American will receive credits that it currently believes will be worth about $285 million over the next four years. The company will also get additional credits from tribal sales that weren't subject to state excise tax. A Reynolds executive explained that the company "is pleased to finally resolve this issue with the State of New York, and now both sides can move beyond this decade-long series of disputes."

In the Reynolds American earnings report, investors need to keep their eyes on how well the Lorillard integration is going. Beyond the huge gain in revenue that bringing Lorillard onboard will create over the next year, Reynolds American still needs to show the synergies that it promised in the run-up to the merger, and although it'll take time for all of those gains to show up, early signs should still be evident. As long as the company remains on its current long-term track, investors don't have much to complain about with Reynolds American's recent success.