Reynolds, Philip Morris defy trends

Cigarette-makers found people still willing to spend even as other industries struggled with a consumer pullback in the third quarter.

Executives of Reynolds American Inc. and Philip Morris International Inc. said yesterday that their results demonstrate how they can defy a downturn.

Reynolds' net income in the quarter slid to $211 million, or 72 cents a diluted share, compared with $358 million, or $1.21 a share, a year ago.

But excluding one-time costs, the company earned $1.29 a share, beating the average forecast of $1.20 by analysts surveyed by Zacks Investment Research.

Susan Ivey, the chief executive of Reynolds, said that the company's performance "speaks to the resilience of the tobacco business, even in tough economic times."

Philip Morris International's profit rose 20 percent in the third quarter as sales climbed and it benefited from favorable foreign-exchange rates. It sells Marlboros, L&M, Chesterfield and Bond Street brands outside the United States.

"No business in the world is actually recession-proof, but I am convinced that our business is very recession resilient," said Hermann Waldemer, the chief financial officer of Philip Morris International.

Reynolds' charges included a pretax trademark-impairment charge of $173 million on its Kool cigarette brand. The charge is part of Reynolds' strategy, announced on Sept. 9, to move Kool from a growth brand to a support brand and to put most of its marketing emphasis on Camel.

Reynolds also took a pretax restructuring charge of $91 million. The company also said on Sept. 9 that it was cutting 570 white-collar jobs, including 320 involuntarily, by early 2010.

Reynolds reported that revenue dipped 1 percent to nearly $2.3 billion despite the volume of its cigarette sales declining 7.5 percent. The loss in volume was partially offset by higher prices and cost savings, the company said.

Because of the better-than-expected report, Reynolds raised its full-year outlook. It now forecasts 2008 adjusted earnings growth in the low single digits, rather than flat results.

"Reynolds' results bode well for both Altria and Lorillard as industry pricing remains healthy and industry volumes only decreased about 3.4 percent vs. our estimate of about closer to 4 percent," Judy Hong, an analyst with Goldman Sachs, wrote in a research note.

Reynolds' Conwood division posted a 10 percent increase in operating profit. Its Grizzly brand delivered double-digit volume growth.

Bruce Davidson, a tobacco analyst for Blue Oar Securities PLC of London, said that Reynolds still faces "some big issues" despite the overall good quarterly performance.

"Such as how long can you see volumes decline in the cigarette business before you have to make further cuts to the fixed costs," Davidson said.

The company said that non-support brands represented 45 percent of the decline in cigarette sales.

Reynolds' two growth brands, Camel and Pall Mall, held 8.1 percent and 2.7 percent market share, respectively. That's up from a combined 10.1 percent in the third quarter of 2007.

But the market share for Reynolds' support brands dipped to 13.8 percent from 14.5 percent a year ago, and the nonsupport brands fell to 3.5 percent from 4.3 percent.

Overall, Reynolds' domestic market share fell to 28.2 percent from 29 percent a year ago.

"We continue to face challenges in the cigarette category," said Daniel Delen, the chairman, president and chief executive of R.J. Reynolds Tobacco Co.

"But we remain pleased with the performance of Camel and with R.J. Reynolds' leadership in establishing the modern smoke-free tobacco category in the United States," Delen said.

Davidson said that it's one thing for Reynolds to say that the "volume trend in the growth brands was good. But they keep reducing the definition of growth brands almost to suit themselves."

Analysts have speculated for weeks that Reynolds may be de-emphasizing Kool as part of preparing a bid for Lorillard Tobacco Co. of Greensboro to buy Lorillard's top-selling Newport menthol brand.

Analysts considered Lorillard a takeover target months before it was spun out from Loews Corp. in June.

"More important might be to ask them why Winston, Doral and now Kool have lost so much ground that they are viewed as cash cows," Davidson said. "Sounds like a gross failure of management.

"Quarterly numbers look OK because we all exclude the ‘one offs,' he said.

"It is worth remembering that when a calculation of trademark impairment is made, then the auditor does it on the basis of future cash flows," Davidson said. "So, presumably, the outlook for Kool is dire if they are writing off $173 million just for Kool."

Journal Graphic by Nicholas Weir - Click to enlarge

Smoking pays

• How they did: Reynolds American Inc.'s profit fell 41 percent, but the results were better than Wall Street had expected and the company raised its full-year profit forecast. Philip Morris International Inc., which sells Marlboros overseas, reported a 20 percent rise in third-quarter profit.

• Reynolds American Inc.: Chief executive Susan Ivey said that the company's performance "speaks to the resilience of the tobacco business, even in tough economic times."

• Philip Morris International Inc.: "No business in the world is actually recession-proof, but I am convinced that our business is very recession-resilient," said the chief financial officer, Hermann Waldemer.

• Brands: Philip Morris International sells Marlboros, L&M, Chesterfield and Bond Street brands. Reynolds sells Camel, Pall Mall, Kool and Grizzly.

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