UPDATE 5-Reynolds American profit disappoints, stock dips

Wed Apr 30, 2008 12:55pm EDT

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(Recasts first paragraph; adds CEO and analyst comments, byline; updates stock action)

By Ben Klayman

CHICAGO, April 30 (Reuters) - Reynolds American Inc (RAI.N) posted weaker-than-expected first-quarter profit on Wednesday due to declines in sales of cigarette brands on which it focuses less marketing and pressure from competitors amid the weak U.S. economy.

The maker of Camel cigarettes and Grizzly smokeless tobacco also cut its full-year profit forecast, citing the challenging economic environment. Its shares fell as much as 8 percent to a two-year low.

"The guidance downgrade ... is due to an increasingly competitive environment in cigarette and smokeless," JP Morgan analyst Erik Bloomquist wrote in a research note. He has a "neutral" rating on the stock.

Reynolds, which competes with Altria Group Inc's (MO.N) Philip Morris USA cigarette unit and UST Inc's UST.N smokeless tobacco businesses, said older, more price-sensitive customers of its R.J. Reynolds tobacco unit were disproportionately hurt by economic pressures that included higher cigarette prices.

Reynolds Chief Executive Susan Ivey said the company was disappointed in the results and the performance of R.J. Reynolds but added that it faced a number of challenges.

"We are ... continuing to see shifts between tobacco products and categories," she told analysts on a conference call, citing growth in such products as little cigars, roll-your-own cigarettes and moist snuff.

The tough economy has not led many people to quit smoking, but it has resulted in more demand for deep-discount cigarettes and lower-priced products, Ivey said. That has benefited the company's Conwood smokeless tobacco business.

Competitive discounting and Reynolds' decision to discontinue a number of lower-priced, lower-margin cigarette brands contributed to volume declines, she said.

"We got a little bit caught in the cross-fire with a lot of competitive promotion, and we obviously will rectify that on the growth brands," Ivey said, adding that she expects prices to stabilize.

Reynolds, based in Winston-Salem, North Carolina, said first-quarter net income rose 54 percent to $505 million, or $1.71 a share, from $328 million, or $1.11 a share, a year earlier.

Earnings were boosted by a $328 million pretax gain from the termination of a joint venture. Payments from that transaction will provide a cash stream over the next six years.

Excluding one-time items, it earned $1.00 a share, 15 cents short of analysts' average forecast, according to Reuters Estimates. Higher payments to U.S. states as required under a 1998 settlement reduced earnings by about 6 cents a share, Chief Financial Officer Thomas Adams said.

Sales fell 4.2 percent to $2.06 billion, short of the $2.14 billion analysts had expected.

R.J. Reynolds sold 20.8 billion cigarettes in the quarter, down almost 12 percent from a year earlier, and the unit's operating income fell 15 percent. Kool, Camel and Pall Mall cigarettes saw market share grow to 13.2 percent from 12.6 percent, but brands such as Doral, Viceroy and GPC, which are not marketed as heavily, suffered lower sales.

Reynolds said its Conwood division grew at twice the industry rate in the first quarter as the number of cans sold rose almost 11 percent to 75.9 million. Profit in the unit rose 1.9 percent, and Adams said it probably will grow at greater rates the rest of the year due to investments in new brands.

In light of the weaker-than-expected results, Reynolds said it now expects earnings for the full year, excluding the gain from the joint venture, to be in line with its adjusted results in 2007. Previously it had forecast a mid-single-digit percentage increase from 2007's $4.57 a share. Analysts' average forecast is $4.82.

Reynolds executives said they expect 2008 U.S. cigarette industry shipment volumes to fall 4 percent to 5 percent, while moist snuff shipments are seen up about 7 percent.

"The results could reinforce investors' heightened concern over the U.S. cigarette industry's volume and profit outlook," Goldman Sachs analyst Judy Hong wrote in a research note. "We continue to expect profitability to improve as the year progresses."

Reynolds also announced a $350 million stock buyback over the next 12 months through open-market and privately negotiated deals, to be covered by operating cash. The program replaces a $30 million buyback authorized in February.

Reynolds' largest shareholder, British American Tobacco (BATS.L), the world's No. 2 cigarette group, has agreed to participate in the buyback at a rate that will maintain its stake in Reynolds at about 42 percent, Adams said.

Shares of Reynolds fell to $53.17 -- their lowest price since April 2006 -- in early trading and were off $3.65, or 6.3 percent, at $54.20 in afternoon dealings on the New York Stock Exchange. (Reporting by Ben Klayman; editing by John Wallace)

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