Reynolds's New CEO Needs New Ideas
Reynolds American can't rely on deals and low gas prices to boost its business forever.
Shares in the second-largest tobacco seller in the U.S. dropped as much as 8 percent Wednesday, after third-quarter sales and profits trailed Wall Street forecasts for the fourth consecutive quarter. The stock did rebound slightly after a cheery conference call with analysts, in which the company announced a new CEO and defended its tightened full-year earnings guidance of 15 percent to 18 percent growth from 2015.
But new CEO Debra Crew should consider the stock's whipsawing a warning sign.
Reynolds stock has lagged competitors in recent months. But like other tobacco companies that have come back from the dead, Reynolds has thrived in recent years. Its shares returned 105 percent over the past three years, compared to the S&P 500's 31 percent return. Lower gas prices helped boost sales 1 , while the decline of smoking rates in developed countries slowed. The percentage of smokers actually grew in some countries, such as Russia, Greece and Chile.
Cigarettes are among the world's most inelastic products; their addictive nature means people keep buying them even when prices go up. Thus Reynolds and others have been able to keep raising prices even as taxes and other costs go up. Reynolds has also been increasing shareholder-friendly moves such as boosting its dividend and share buybacks.
Outgoing CEO Susan Cameron artfully orchestrated a $26 billion takeover of Lorillard, which helped usher in higher-quality tobacco brands. The maker of the Newport menthol-cigarette brand, which is popular with sought-after millennial customers, helped boosted Reynolds's gross margins to roughly 63 percent in the third quarter, up from 54 percent in the third quarter of 2014.
But as Reynolds pointed out Wednesday, full synergies from the Lorillard deal will be realized in the fourth quarter. Meanwhile, U.S. gas prices are starting to creep up again, and the decline in smoking rates has re-accelerated. Investors may soon be asking Reynolds: What have you done for me lately?
Meanwhile, competitors Altria and Philip Morris are gearing up to aggressively chase market share in the U.S. by introducing iQOS heat sticks, which heat tobacco instead of burning it. They plan to roll out the cigarette alternative in America as soon as next year. Wells Fargo analyst Bonnie Herzog estimates the heat sticks could displace 30 percent of cigarette sales in developed markets by 2025.
Reynolds has been testing its own heating technology, but those tests have been disappointing so far. Reynolds risks getting left behind if these devices start to overtake e-cigarettes, notes Bloomberg Intelligence analyst Ken Shea.
On Wednesday, Reynolds executives punted on multiple questions about the threat of Philip Morris and Altria's heat sticks, telling analysts they would comment further at the annual investor meeting in November 2 .
That gives the company and its new CEO about a month to perfect a strategy that goes beyond benefiting from lower gas prices and lofty acquisitions. That strategy should include growing its non-combustible business and preparing for potential heat-stick competition next year. Investors are looking for a little more fire than they're getting so far.
Half of all tobacco sales occur at a gas station, according to Euromonitor, so low gas prices tend to leave consumers with extra money to spend on cigarettes, which boosts sales.
Out of the 17 questions analysts asked Reynolds on its quarterly call Wednesday, six were answered with some variation of "We'll talk about that in November" at its annual investor day.
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