PM USA Reducing Off-Invoice Promotional Allowances

Analysts expect Reynolds, Lorillard to follow Altria's lead

NEW YORK -- Altria Group Inc. announced to the trade late Wednesday that effective Monday, June 10, it will be reducing off-invoice promotional allowances on Philip Morris USA's Marlboro and L&M brands by six cents per pack to 15 cents per pack and 28 cents per pack, respectively, and raising list prices on all other brands by six cents, Nik Modi, analyst for UBS Securities LLC, New York, said in a research note.

The other brands include Basic, Benson & Hedges, Cambridge, Chesterfield, Commander, Dave's, English Ovals, Lark, Merit, Parliament, Player's, Saratoga and Virginia Slims.

"We expect Lorillard and Reynolds will follow Altria's move in the near future. This price increase supports our thesis that [Altria] is shifting its focus to price realization and could report up to 4.4% pricing for 2013," Modi wrote.

"We continue to see pricing as the key driver of tobacco profits and stock performance," he added. "We believe Big 3 tobacco is favorably positioned as the group continues to take market share from deep-discount players who are struggling in an environment with a higher cost of business largely due to new [Food & Drug Administration] regulations. We believe all Big 3 names should benefit from sustainable pricing."

Bonnie Herzog, managing director for beverage, tobacco and convenience store research for Wells Fargo Securities LLC, New York, said in a separate research note, "We expect the tobacco stocks to react favorably [Thursday] to news of this price movement; however, this may not be perceived as favorably for retailers as it is generally easier for retailers to take price increases following list price increases versus promo reductions."

She added, "We expect Q2 2013 industry cigarette volume should be in line with historical trends given inventory building by wholesalers in advance of this price increase could offset volume pressures due to [electronic cigarettes]. We expect overall cigarette net price realization to accelerate in 2013 to around 4% and we have further conviction industry topline will improve during Q2 and beyond driven by solid volume trends, higher prices, and easing promotional spending. Pricing is crucial to tobacco manufacturers given they realize about 3x the earnings leverage from a point of pricing vs. a point of volume. Overall this is positive and indicates continued pricing power. Given that consumption will likely continue to decline in the midsingle digit range, pricing is necessary to drive topline."

Herzog predicts that PM USA "will get more aggressive, offering creative, innovative products and lower promos in 2013 to maintain its reign at the top of the U.S. tobacco market."

Richmond, Va.-based Altria is the parent company of PM USA, U.S. Smokeless Tobacco Co. and John Middleton. Altria also owns Ste. Michelle Wine Estates, Philip Morris Capital Corp. and has a continuing economic and voting interest in SABMiller.