Herzog: Total Tobacco Strategy Key to 2013 Success

Wells Fargo analyst predicts innovation, believes Altria will draw profits in new year

Melissa Vonder Haar, Freelance Writer

NEW YORK -- A new year has arrived and with it comes Wells Fargo's "Integrated Research & Economics Outlook" report, outlining sector forecasts and top investment recommendations from the New York City-based financial services company's senior analysts. And although tobacco slightly underperformed in 2012, analyst Bonnie Herzog sees lots of reasons to be optimistic about the category in 2013.

"We are very encouraged by innovation in the tobacco sector, which we expect to drive growth," Herzog wrote in the January 4 report. "We expect cigarette net price realization to accelerate to the mid-single-digit area in 2013 and this pricing power, combined with cost savings initiatives, should lead to continued strong earnings growth."

As to which company will lead the charge, Herzog named Philip Morris and its parent company Altria Group Inc. as her "top pick of 2013." A large part of Herzog's confidence in the Richmond, Va.-based company comes from the strength of its Marlboro brand.

"[Philip Morris'] reinvigorated Marlboro portfolio, arguably one of the highest brand equity franchises in the world, should benefit from consumer up-trading trends, thereby driving robust pricing power and share gains."

And though Marlboro has long enjoyed the title of "top seller" in the cigarette segment, Herzog noted that Altria has continued to strive to find ways to improve the both the brand and its place in the retail environment.

"As [Altria] further implements and refines its strategy around Marlboro's innovative brand architecture, we are optimistic that Marlboro's brand equity and the relevance of the brand will improve," Herzog said. "Further, we are seeing signs that Philip Morris USA is achieving a better balance between leveraging Marlboro for profitable growth and maintaining strong brand equity."

However, the tobacco sector is not just about cigarettes, especially with fewer and fewer people in the United States consuming the product--a trend Herzog believes will continue in 2013.

"Over the next year, we believe cigarette consumption will continue to decline in the U.S.," she said, "highlighting the importance of an innovation-driven, total tobacco strategy that includes smokeless tobacco and e-cigarettes in addition to traditional cigarettes."

Herzog continued that Altria is one company that is "solidly executing on its 'total tobacco' strategy." The key to tobacco success comes down to a balance between profits from traditional category leaders--such as cigarettes--and the new wave of innovative products that could prove invaluable to the future of the tobacco sector. Herzog believes Altria is doing just that.

"We continue to believe it is critical for [Altria] to grow its core [Marlboro] to finance growth in other faster-growing and very profitable categories such as smokeless tobacco," Herzog said. "We are more optimistic that [Altria] is closer to reaching this balance, and we expect the company may be more transparent about its product and innovation pipeline across the total tobacco spectrum as the year unfolds."