Tobacco’s New Big Three: One Year Later

Last year at this time, a lot of questions surrounded the planned merger of Reynolds American Inc. (RAI) and Lorillard Inc. and the expansion of Imperial Tobacco Group plc to a larger portion of the U.S. tobacco business. As the cover story of Convenience Store News’ April 2015 issue reported, the majority of convenience store retailers anticipated the shakeup would be a good thing for them, bringing increased competition to the tobacco supplier community.

The merger became official on June 12, 2015. Winston-Salem, N.C.-based RAI acquired Lorillard, and at the same time, London-based Imperial Tobacco Group (now known as Imperial Brands plc) acquired several RAI and Lorillard brands, plus Lorillard’s Greensboro, N.C., operations. A new Big Three — as the top tobacco companies are dubbed — emerged.

When the dust settled, Richmond, Va.-based The Altria Group Inc. kept its title as the No. 1 player in the U.S. tobacco space. RAI remained the No. 2 player, but was now bolstered by Lorillard. And ITG Brands LLC (the name Imperial gave its U.S. business) became the new No. 3.

So, what’s happened since then? Has anything really changed for convenience store retailers that sell tobacco? Has the shakeup delivered on the positive predictions?

To find out, CSNews catches up with tobacco’s new Big Three.

FROM ALTRIA’S PERSPECTIVE

Since the merger of its competitors, Altria has not seen any real significant change in the competitive landscape that it did not previously contemplate, Marty Barrington, chairman, president and CEO, said during the company’s fourth-quarter earnings call in January.

“The brands have some new owners, and [those] owners talked about their plans about what to do with the brands at retail. We fully contemplated that, but we haven’t seen anything that I’d call out as significant or material,” observed Barrington.

The company’s standard operating procedure has largely continued without interruption, Brian May, Altria’s senior manager of communications, further explained to CSNews.

“We always evaluate and contemplate what our competitors are doing, but we haven’t seen anything that would significantly alter our plans for the year,” May said.

Altria’s numbers across its stable of operating companies back this up. The tobacco leader had a productive 2015. Overall, it grew full-year 2015 adjusted earnings per share (EPS) by nearly 9 percent, in line with its long-term EPS growth objective. In addition, Altria returned nearly $4.2 billion in dividends to its shareholders, consistent with the company’s goal of paying out approximately 80 percent of its adjusted, diluted EPS.

Looking ahead, May said, “Altria and its operating companies are well-positioned for continued success. Our core tobacco businesses are strong, thanks in part to the investments we’ve made in our premium brands.”

Altria also completed a $1-billion share repurchase program and announced a new $1-billion share repurchase program it expects to complete by the end of 2016.

Still, Altria is not resting on its track record. Its operating company, Phillip Morris USA, expanded Marlboro Midnight Menthol nationally in November. Its U.S. Smokeless Tobacco Co. is bringing Copenhagen Mint to the national market later this quarter. And its Nu Mark LLC subsidiary is continuing to build a portfolio of new tobacco products by leveraging internal capabilities and a partnership with Philip Morris International on heat-not-burn products.

FROM RAI’S PERSPECTIVE

For RAI, 2015 was certainly a “transformational year,” as President and CEO Susan Cameron noted during the company’s latest earnings call in early February.

A major piece of the transformation has been the addition of the Newport brand — which was formerly Lorillard’s leading brand — to RAI’s R.J. Reynolds Tobacco Co. portfolio. RAI expects to complete the manufacturing transition of Newport to its Tobaccoville facility this year. In addition, the brand was added to R.J. Reynolds’ retail contracts in mid-November, following the expiration of the initial five-month standstill period.

“The [Newport] brand’s expanded presence is delivering additional gains. We saw growth in both the premium menthol styles, as well as in Newport Red,” Cameron said. “We also believe contributing to that, in addition to the contracts and the larger sales force, is the consumer engagement strategy. We are out there talking to smokers and talking about the Newport brand in markets where it really hasn’t been represented.”

Industry analysts Bonnie Herzog, managing director of tobacco, beverage and convenience store research at Wells Fargo Securities LLC, and Vivien Azer, director and senior research analyst at Cowen and Co., both agree Newport is a bright spot for RAI.

Newport is poised for greater-than-expected share gains and faster growth, strengthening the company’s long-term profitability, Herzog observed after RAI released its fourth-quarter results.

Citing Wells Fargo Securities’ latest Tobacco Talk survey, she said retailers now expect Newport to gain roughly 95 basis points of incremental share in 2016 under RAI’s ownership, up from approximately 80 basis points when posed the same question in early December 2015.

In fact, one retailer in the latest survey said R.J. Reynolds Tobacco “gained major power with Newport. It’s really a two-horse race now.”

Added Herzog: “We believe RAI is now well-positioned to drive share gains and margin expansion, while managing its growth brand pricing structure and accelerating growth for Newport and its entire portfolio.”

February marked the third consecutive month that Newport delivered accelerating share gains, Azer cited.

FROM ITG’S PERSPECTIVE

Since the beginning, the biggest question mark in the shakeup has always surrounded ITG and whether it could be a viable No. 3 competitor to Altria and RAI.

While the company is still in its early days, Alison Cooper, chief executive of Imperial, revealed in trading statements that the company as a whole continued to make good progress against its strategic objectives for the three months ended Dec. 31.

In the United States, “the ITG Brands team has made excellent progress in the quarter successfully executing our retailer and wholesale program, and establishing the foundations for a year of strong delivery,” Cooper stated. Consistent with the better trends seen in the U.S. market, ITG’s parent company remains constructive on the trading environment, Azer pointed out. The company also remains encouraged by the market share trends for Winston and Kool — two of the brands it acquired — after doing more work on brand equities over the course of the deal. However, Azer did note in her analysis of cigarette volume from Nielsen’s all channel data for the four weeks ended Feb. 27 that ITG’s volume share fell 0.4 points in the period due to share losses from Maverick, Kool, Salem and Sonoma. Winston’s share was flat in the period. The company fared slightly worse on a dollar share basis, losing 0.5 points in the period.

Similarly, Herzog in her analysis of the latest numbers observed ITG’s “volume declines markedly accelerated to −5.9 percent during those four weeks (vs. −4.1 percent for 12 weeks) as volume for three of its top cigarette brands — Maverick, Kool and Salem — declined 9.7 percent on average.” The company’s “severe topline underperformance” translated to a 60 basis point year-over-year loss in retail share, to 7.2 percent, she added, noting that ITG’s losses appear to be RAI’s gains in regards to the Newport brand.

“The [Newport] brand’s expanded presence is delivering additional gains. We saw growth in both the premium menthol styles, as well as in Newport Red. We also believe contributing to that, in addition to the contracts and the larger sales force, is the consumer engagement strategy. We are out there talking to smokers and talking about the Newport brand in markets where it really hasn’t been represented.”
— Susan Cameron, CEO, Reynolds American Inc.