Altria Group Inc (MO), Reynolds American, Inc. (RAI), Lorillard Inc. (LO) & The Road Ahead for Domestic Big Tobacco

Page 1 of 2

Altria Group Inc (NYSE:MO)The domestic tobacco industry is full of contradictions. Share prices continue to rise despite declining cigarette sales. Profits keep growing despite rising excise taxes. Dividends remain pleasantly plump, often outgrowing earnings per share.

Keeping those factors in mind, how does the road ahead look for the three largest tobacco companies in America – Altria Group Inc (NYSE:MO), Reynolds American, Inc. (NYSE:RAI) and Lorillard Inc. (NYSE:LO), and should investors still have faith in this oft-vilified industry?

First quarter breakdown

All three companies recently reported their first quarter earnings. Their results were similar, featuring rising profit, flat revenue growth, and declining cigarette shipment volumes. Let’s take a look and how these three companies fared during the first quarter.




1Q Year-on-Year Profit Growth





1Q Year-on-Year Revenue Growth





Cigarette Sales Volume





Total U.S. Market Share





Biggest Brand(s)





Altria




+16%



-2.1%



-5.2%



50.5%



Marlboro




Reynolds American




+88%



-2.6%



-5.6%



26.1%



Camel, Pall Mall




Lorillard




+47%



+6.0%



-2.0%



14.9%



Newport

Source: 1Q Earnings Reports

Although Altria Group Inc (NYSE:MO) grew the least out of the three companies, its market share continues to rise, up from 50% in the prior year’s quarter. Altria Group Inc (NYSE:MO)’s Marlboro brand controls a whopping 42.6% of the U.S. cigarette market by itself. Meanwhile, Reynolds American, Inc. (NYSE:RAI) reported rising profits but lost market share, while Lorillard Inc. (NYSE:LO)’s market share rose slightly, boosted by strong sales of its menthol brands.

Some investors believe that investing in the U.S. tobacco industry – which is shrinking due to increasing regulation, higher excise taxes, and more health conscious consumers – is a foolish strategy. Yet I believe that these three leading tobacco companies are tightly run ships which have used strong dividend payouts, aggressive share buybacks, strategic acquisitions and tactical cost-cutting strategies to continue growing.

Alternative tobacco

Investors shouldn’t fret about declining cigarette sales volume in the United States. To offset these expected losses, Altria Group Inc (NYSE:MO) and Reynolds American, Inc. (NYSE:RAI) own steadily growing brands of snuff, cigars and smokeless alternatives.

Through its acquisition of UST, Altria Group Inc (NYSE:MO) controls over half of the domestic snuff market with its Copenhagen and Skoal brands. Reynolds American controls 33% of the snuff market with its Grizzly and Kodiak brands.

Altria Group Inc (NYSE:MO) also entered the niche cigar business through its purchase of John Middleton Cigars, which controls 30% of the domestic market for machine-made cigars with its Black & Mild brand. It also owns stakes in brewer SABMiller and winemaker Ste. Michelle Wine Estates. Reynolds American, Inc. (NYSE:RAI) also invested in nicotine gum Zonnic to diversify away from cigarettes.

Although these non-cigarette brands comprise a much smaller slice of the top line than traditional cigarettes, they are steadily rising in significance. Lorillard Inc. (NYSE:LO), which has traditionally been the market leader in menthol cigarettes, notably offers fewer non-cigarette products.

However, Lorillard has a major ace up its sleeve – electronic cigarettes.

Electronic cigarettes

Many analysts believe that electronic cigarettes will be the next hot product for the tobacco industry worldwide. E-cigarettes use an electric charge to convert nicotine cartridges into vapor, which is inhaled to deliver nicotine directly into the lungs without cancer-causing smoke and tar. They even have electric lights on the tips that help smokers replicate the feeling of smoking.

Lorillard Inc. (NYSE:LO) owns blu eCigs, which controls 40% of the U.S. electronic cigarettes market. Lorillard estimates that e-cigarettes replaced the consumption of approximately 600 million cigarettes during the first quarter. This translates to a possible 2.4 billion e-cigarettes sold annually – or 1% of the total domestic cigarette market. That sliver has been steadily growing since 2006. Bullish analysts forecast that total industry-wide e-cigarette sales this year could double year-on-year to $1 billion.

Lorillard Inc. (NYSE:LO) announced that it was launching a new rechargeable e-cigarette kit that will sell for half the price of its current product. Stronger marketing initiatives and wider distribution channels helped blu eCigs contribute $57 million to Lorillard Inc. (NYSE:LO)’s top line in the first quarter, up from $39 million in the fourth quarter. Retailers have also noticed the rising popularity of blu eCigs – distribution points rose to 80,000 in the first quarter, up from 50,000 in the previous quarter.

Page 1 of 2