Big acquisitions have big impacts, and the deal by which Reynolds American (NYSE:RAI) bought out rival Lorillard created a behemoth that now poses an even bigger threat to tobacco-industry leader Altria Group (NYSE:MO) than it did before. Investors have celebrated the merger by sending Reynolds stock to all-time highs, and coming into its third-quarter financial report, Reynolds investors were anxious to see just how huge an effect having Lorillard in the fold would have on the post-merger company's results. Reynolds largely gave investors exactly what they had expected to see, and that should bode favorably for the company's future prospects.
Let's look more closely at how Reynolds American did in its first full quarter after the merger and what it tells investors about its potential for the future.
Reynolds American sees big boosts in its financials
As you'd expect from a major merger, Reynolds American's third-quarter report looks a lot different from how it did a year ago. Revenue soared 41% to $3.16 billion, edging out the $3.15 billion consensus forecast among investors. Adjusted net income jumped at an even faster 55% pace, and that worked out to adjusted earnings per share of $0.55, exactly matching what investors had expected to see from the company.
Looking more closely at the numbers, Reynolds American saw adjusted operating income from its key RJR Tobacco unit rise by nearly two-thirds, with the addition of Lorillard's Newport brand helping to lift the segment's results. Adjusted operating margins soared more than five percentage points, and Newport's market share grew by half a percentage point to 13.3% despite the fact that FTC regulators have prohibited Reynolds American from making any changes to Newport's retail merchandising strategy until the middle of November. Declines in Pall Mall's market share offset some of Newport's gains, but Reynolds American's top three brands, which include Newport, Pall Mall, and Camel, together saw shares climb to 29.4%.
Other segments also contributed to Reynolds American's success. The super-premium Santa Fe unit saw operating income jump 23%, with the successful expansion of the Natural American Spirit brand continuing to boost its overall penetration into the marketplace. Meanwhile, the American Snuff smokeless tobacco unit also enjoyed gains, with operating income rising 12%, and Reynolds American products now command more than a third of the overall moist-snuff retail market, led by the flagship Grizzly brand and its recent expansion with the Dark Wintergreen style.
CEO Susan Cameron was pleased not only with the results, but also with the progress in reaping the benefits of the Lorillard merger. "Our operating companies delivered excellent key-brand performance in the third quarter," Cameron said. "In addition to these strong results, I'm pleased to report that the integration of Newport is going smoothly." In particular, Cameron pointed to actions among Reynolds' sales teams to make the most of Newport in their efforts to find new avenues for growth.
What's ahead for Reynolds American?
As important as the Lorillard merger has been, Reynolds American actually has many different initiatives going on right now to drive growth in other areas. Expansion of the VUSE digital-vapor cigarette in September added four new styles, and the company successfully consolidated manufacturing of VUSE products at its key Tobaccoville production facility. With Reynolds having signed a technology-sharing and licensing term sheet with British American Tobacco, it's clear that the company is standing up to Altria and its efforts to emphasize alternative products as part of its overall growth strategy.
Financially, Reynolds American's success led the company to raise the lower end of its previous guidance. The company now expects to earn between $1.94 and $2 per share. CFO Andrew Gilchrist once again emphasized the importance of repaying debt incurred in the Lorillard transaction, with plans to repay $450 million in debt maturing at the end of October. It's also likely that Reynolds American will use part of its $5 billion payment from Japan Tobacco for the international rights to market Natural American Spirit cigarettes toward paying down debt.
The immediate reaction to Reynolds American's latest results wasn't all that favorable, with the stock falling precipitously in the opening minutes of Tuesday's trading session following the announcement. In the long run, though, Reynolds American is demonstrating the discipline and strategic vision it needs to make the most of what it gained in the Lorillard merger, and so far, the company has made significant progress toward fighting against Altria in the future.