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On what continues to be nasty volume trends across the cigarette industry, RAI reported relatively solid results in Q2. Despite volume declines of -6% (above the industry average of -6.1%) and RAI's total market share down 0.3% to 26% versus the prior-year quarter, the company was able to offset volume declines by pricing and strong performance from Camel and Pall Mall, its two growth brands in the premium and value categories, respectively, and positive results from Camel SNUS (80% market share) and moist-snuff leader Grizzly that saw brand share up 1.0% in the quarter.

We’re optimistic on RAI’s 2H performance due to the migration and growth of smokeless tobacco and e-cigs as contributing factors offsetting declining cigarette volume trends and tougher comps in the back half of 2013.

We do expect cigarette volume declines to persist. The company expects volumes to decline 4-5% for the year and cited such contributing factors as: ongoing weakness in the economy, high unemployment, higher retail prices, and tougher comps given lower volume declines last year (-2.3%), and growth in smokeless tobacco and smoke-free technologies like electronic cigarettes (e-cigs).

On e-cigs: the company looks to continue to invest in its e-cig brand VUSE in the back half.  Interestingly, it opened its earnings call by underling that it’s excited that VUSE is expanding into its first major market, Colorado. In the Q&A, the company noted that VUSE will grow to have a commanding presence in the e-cig market, already out in 500 retail stores in the first week, with a flavor profile it calls superior to its competitors.

On industry trends, it claims it’s too early to talk about the consumer response, but said retailers are extremely positive. It noted that while e-cigs have strong trialing, so far the conversion is low. RAI also said that while its products may have product displays at retail that are available to the customer, it’s a clerk-assisted sale with the actual product housed behind the counter.

On Menthols and the FDA: Yesterday the FDA released a second review on menthol cigarettes that essentially reached the same conclusion of its first: menthol cigarettes appeal disproportionately to younger smokers and are more addictive than other cigarettes. This is noteworthy given that one-third of RAI’s total cigarette volume is menthol.

RAI took numerous questions on its outlook and strategy given the announcement, but its only main response was it will continue to review the proposed rule making before responding. 

In response to the first report, Big Tobacco filed its own report with the FDA, making the case that menthols pose no different risk to public health than any other cigarette and therefore should not be subject to special regulation. It also sued the FDA over the experts it had appointed to the Tobacco Products Scientific Advisory Committee tasked with the 2011 study.

We’ll be monitoring both the regulatory and company actions in response to this release.

Results: On the quarter, EPS beat consensus by one cent at $0.84. Revenue was lighter at $2.18B vs the Street at $2.19B, and increased 0.1% versus the prior-year quarter. RAI repurchased 3.1 million shares for $150MM.  On the year, RAI reaffirmed EPS ex-items of $3.15-3.30.

Matthew Hedrick

Senior Analyst