Reynolds American Inc.RAI

Morningstar Rating

Stock Research and Analysis

by Philip Gorham, CFA

We believe the addictive nature of cigarettes, the strength of its portfolio of brands, and its scale of operations give Reynolds American a narrow economic moat. However, Reynolds faces some strong competition from Altria MO, the price leader in the Read more

Bulls Say

Reynolds American holds the number-two position in the domestic cigarette manufacturing industry and owns five of the top ten brands across a range of price points.

Conwood, the smokeless tobacco segment, has been the jewel in Reynolds' crown, providing top line growth and enhanced profitability without much of the litigation that has hindered the cigarette industry for years.

Reynolds has rationalized its brand portfolio and concentrates its promotional spending only on the largest and most profitable brands. Approximately 63% of its cigarette portfolio is positioned in the more profitable premium sector.

The cost savings from the restructuring initiative could create a war chest and be used to cut prices in order to compete with the aggressive price cuts on smokeless products announced by Altria.

Reynolds has demonstrated innovative culture, with new lines of products including Camel Snus, Camel Signature, and Camel Crush. Read more

Bears Say

Altria's acquisition of UST is likely to intensify competition in the tobacco industry. We fear that as Reynolds reacts to more aggressive pricing strategies by Altria, its operating margins will suffer.

The increase in federal taxes on tobacco products, which took effect April 1, is likely to accelerate the rate of decline in the consumption of cigarettes in the short term.

Reynolds' older customer demographic could lead to accelerated declines in consumption of its brands relative to the rest of the industry.

Sales could be significantly affected by any restrictions on the sale of menthol cigarettes. Reynolds has indicated its intention to leverage the Camel brand to gain ground in the menthol segment.

The sale of the international rights to its brands to Japan Tobacco and a noncompete agreement with BAT preventing it from selling B&W brands abroad may limit Reynolds' opportunities for overseas expansion. Read more

Strategy

Reynolds concentrates its promotional support on its two main growth brands, Camel and Pall Mall, but is willing to allow its nonsupport brands such as Winston, Salem, and Doral to decline. In the smokeless Read more

Management

Reynolds has taken some steps this year to bring fresh blood into the boardroom and improve the independence of its board. The replacement of the retiring Joseph Viviano in May 2009 with Luc Jobin and Holly Koeppel brings the ratio of independent directors Read more

Profile

Reynolds American is the second-largest domestic cigarette manufacturer, behind Altria, with a portfolio of brands that includes Camel, Kool, and Pall Mall. In 2006, Reynolds Read more

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