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Price Rise Not a Snag: Cigarette Profits at Reynolds Up 12% Despite Cost

July 31, 2008

By Richard Craver, Winston-Salem Journal, N.C.

Jul. 31–The acceptance of higher-priced cigarettes by smokers and their increasing use of smokeless products increased Reynolds American Inc.’s profit by 12 percent in the second quarter, the company said yesterday.

The net income of $364 million came despite a slight dip in sales to $2.3 billion.

Diluted earnings rose 14 cents to $1.24 a share. The earnings beat by 5 cents the average forecast of analysts surveyed by Zacks Investment Research.

Investors reacted to the positive news by sending the share price to its largest one-day increase since October 2003. It closed at $55.06, up 6.7 percent, or $3.45 a share.

The share price, however, is down 24 percent from its 52-week high of $72 Jan. 9.

In September, Reynolds raised its cigarette prices by a range of 5 to 15 cents a pack, including 15 cents for Camel, its most popular brand.

The company reported that cigarette sales were down 2 percent to just more than $2 billion. Sales in its Conwood smokeless division were up 8 percent to $188 million, with all other tobacco sales were up 11 percent to $117 million.

“R.J. Reynolds continues to increase total growth-brand market share, and the company is generating additional productivity and profit gains,” said Susan Ivey, the chairwoman, chief executive and president of Reynolds. “With the improved dynamics in the cigarette marketplace and the continued momentum of Conwood and the moist-snuff category, we are confident that we will achieve our (earnings) forecast.”

Matt Reilly, a contributing analyst to The Motley Fool financial Web site, said that “the game in the tobacco industry is mitigating the industry decline in cigarette sales.”

“Reynolds has become especially good at controlling costs and increasing sales of its smokeless brands,” Reilly said.”It also is succeeding in expanding its Camel line without harming the core brand.”

Camel’s market share for its filter cigarette sales was 8 percent on June 30, up from 7.8 percent a year ago, according to data from Management Science Associates Inc., a research group. Kool’s market share was unchanged at 3.1 percent, while Pall Mall’s market share rose to 2.6 percent from 2.1 percent.

But the company’s overall market share dropped to 28.1 percent from 29.1 percent a year ago as it had slight declines in sales of its support brands (Capri, Doral, Misty, Salem and Winston) and nonsupport brands.

Adam Spielman, an analyst with Citigroup, said that Reynolds is limited in how much further it can raise cigarette prices. “We believe Reynolds can no longer raise prices unless Philip Morris USA does as well because the consequence of raising prices ahead of Philip Morris USA is now an unacceptable loss of volume,” Spielman wrote.

“We do believe that Philip Morris USA will start to raise prices, but relatively modestly, and at a pace to suit Altria, not Reynolds. All this combines to mean that Reynolds’ volume performance will be weaker than the other main players in the industry.

“Reynolds is well placed in smokeless, and its strongest brands, Camel and Grizzly, are growing well,” Spielman said.

Reynolds plans national distribution of its Camel Crush line in September. The cigarette contains a blue capsule in the filter of a regular Camel Lights cigarette. When the capsule is squeezed and snapped, it releases menthol to change the flavor.

The company also plans to expand distribution of its Camel Snus product, a spitless, smokeless product that has been in test markets, including the Triad and Triangle, for two years.

Conwood expanded national distribution of its Grizzly Snuff and Grizzly Wintergreen Pouches during the quarter. Both products are in about half of the outlets where they ultimately will be sold.

The company reported it has bought 2.2 million shares, valued at $118 million, of the $350 million share-repurchase program it began in the second quarter.

Richard Craver can be reached at 727-7376 or at rcraver@wsjournal.com.

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