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Reynolds American, Inc. (NYSE:RAI) was able to report strong earnings and margins for the third quarter, despite the sluggish economy and intense competition. Improvements in margins and earnings reflect the company's strength in the market. It continues to improve upon its productivity to maintain its earnings momentum. However, it experienced significant sales volume decline of 6.9%; net sales were down 3.8% YoY.

With passing time, regulations and health concerns on cigarettes are increasing. This has led to lesser number of smokers worldwide. The U.S. experienced a significant decline in the number of smokers in the last four decades to 20% from 40% of population. This is also evident by the fact that the tobacco industry's volume declined by 2.7% in the recent third quarter. The regulations faced by tobacco companies include restricted advertisement, plain packing and more. These regulations mean that in future there will be a shift from traditional smoking to alternate tobacco products, and tobacco companies need to come up with new products to address potential demand of these products. The company is promoting its cheaper brands and alternate-to-traditional cigarettes to attain growth due to weak consumer spending and health concerns.

The second largest tobacco company in the U.S., RAI, reported its financial results for 3Q2012 today. The company reported strong margins and profits, but revenues were down. The company reported adjusted earnings per share of $0.79 and net income of $420 million for 3Q2012, up 6.8% and 6.6% respectively, as compared to 3Q2011. Earnings for the quarter were in line with the market consensus. Reported net sales for the quarter were $2.12 billion, down 3.8% YoY. Revenues for the quarter missed the consensus by $80 million. Revenues for the company were down for three consecutive quarters. For the first three quarters of 2012, revenues for the company were down 2.9%, 4% and 3.8%, respectively. Sales volume for the company declined by 6.9%, partially offset by higher prices. Volume decline for the company was more than that of its industry, which declined by 2.7% in the quarter.

Due to intense competition and aggressive advertisement in the industry, in the recent third quarter, the company's market share was down 1% YoY to 26.4%. RAI's two popular brands, Camel and Pall Mall, had a combined market share of 17.2% in 3Q2012, in line with the previous year's quarter. RAI has been promoting Pall Mall, which is a more economical brand, to address weaker economic conditions in the country.

Despite the revenue decline, RAI was successful in improving upon its margins. The company is working to improve upon its productivity so that it can compete effectively in the highly competitive industry. For the recent third quarter, selling, general and administrative expenditures for the quarter were down 20% YoY. The table below shows the improvement in margins in 3Q2012 as compared to the previous year's quarter.

 

3Q 2011

3Q 2012

Gross Profit Margin

49 %

49 %

Operating Income Margin

31 %

34 %

Net Income Margin

18%

20%

Source: reynoldsamerican.com and Qineqt s estimates.

RAI is expecting full year adjusted earnings per share in the range of $2.91 to $3.01, in line with analyst expectations. Revenues for the company are expected to be $8.41 billion.

The company has been sharing its success with its shareholders and is expected to continue to do so. RAI offers an attractive dividend yield of 5.6%, which is backed by a free cash flow yield of 6.1%. In the third quarter, it repurchased $300 million worth of 6.5 million shares under the share repurchase program of $2.5 billion, started last year.

 

Dividend Yield

Forward P/E

Debt to Equity

RAI

5.6%

13x

67%

Altria Group Inc. (NYSE:MO)

5.4%

13.5x

317%

Lorillard, Inc. (NYSE:LO)

5.3%

12.3x

-

Philip Morris International, Inc. (NYSE:PM)

3.9%

15x

-

Source: Yahoo finance

RAI offers a higher dividend than its competitors, but that is mainly because of its higher payout of 89%. It has lower debt as compared to its competitors. Its forward P/E of 13x is on the lower end of its competitors. The stock is down 4% on the earnings release for the third quarter of 2012. Tobacco stocks are down mainly on concerns of decreasing sales volume. We would recommend investors to wait for the right time to buy the stock, as prices of tobacco stocks can take further dips since companies are in the process of reporting their quarterly earnings.

Source: Wait Before You Buy Reynolds American's 5.6% Dividend Yield