Tobacco Companies to Get Aggressive on Pricing

Analyst says heightened promotional activity will be "headwind" for next few quarters

WINSTON-SALEM, N.C. -- Reynolds American Inc. and Lorillard Inc. touted plans to get aggressive on cigarette pricing to combat promotions offered by rival Altria Group Inc., which has been winning market share as overall volumes fall, according to a Dow Jones report.

Altria, which often leads the industry when it comes to pricing decisions as it commands about half the overall domestic tobacco market, has in recent months sought to increase market share and improve volume by issuing promotions that lower the price for some of its products.

In the first two quarters of the year, Altria's total cigarette market share grew, reflecting gains by Marlboro and discount L&M products and volume performing better than the broader industry's decline, the report said.

Third-quarter results are due Thursday and analysts say they expect Altria will notch further market share gains on a year-over-year basis, after Reynolds American posted a steep decline in volume and Lorillard only modestly outperformed. Altria representatives declined to comment to the news agency.

Executives at Reynolds American and Lorillard suggested to Dow Jones that the promotions have gotten more disruptive in recent months. They both blamed a competitor without directly naming Altria for their moves to take pricing actions on some of their own brands.

Though domestic tobacco producers have been successful in enacting price increases in recent years to help offset volume declines, that pricing power has lessened as Altria's promotions are driving Reynolds American and Lorillard to get defensive, the report said.

Some observers worry the trend to offer more promotions could dent earnings growth over the next several quarters. Reynolds American and Lorillard both only managed to report a small increase in third-quarter earnings, and Altria is only expected to report a 3% profit increase when it reports results on Thursday, according to Dow Jones, citing estimates by analysts polled by Thomson Reuters.

Morningstar analyst Thomas Mullarkey said he expects the heightened promotional action will be a headwind for the industry for the next two to four quarters, though over the long term, he expects more discipline, said the report.

Reynolds American's domestic cigarette market share has eroded on a year-over-year basis for six consecutive quarters. On Tuesday, the company said it would pivot from an earlier strategy to keep price points on Camel and Pall Mall broadly stable.

President and CEO Daniel Delen said the company would aim promotions around specific styles and brands, as well as by geography. But Delen also hopes to maintain the brand equity built into premium-priced brands, particularly in Camel. That suggests there are some limits to how much profitability Reynolds American is willing to cede to capture market share, said the report.

Lorillard said the gap between the price of premium-priced Newport and competitor brands has grown, and while volume has been minimally hurt, the company needs to adjust.

Chairman and CEO Murray Kessler told analysts during a conference Lorillard would never plan to price Newport as low as its competitors, saying that while consumers could buy a rival product for between 80 cents to $1.50 per pack less than Newport in the third quarter, the company saw only a small hit to volume.

"The cost of business has been raised, not by us, by our competitor," he told Dow Jones. "We're not trying to get more aggressive by reducing prices below them." Instead, Lorillard is sticking with price gaps that have historically worked for Newport.

Jefferies & Co. analyst Thilo Wrede told the news agency that Lorillard's pricing held up surprisingly well during the quarter, though volume suffered as a result of Altria's promotions. He said the promotions were a broad concern for the industry as higher prices are needed to offset volume declines, "and right now, the pricing isn't there."

Wrede added that he expects Altria executives on Thursday will not announce plans to scale back promotions, saying they will likely tout the market share gains they are projected to report.