Altria: Silver Lining In The Reynolds-Lorillard Deal?

The Reynolds-Lorillard deal seems to be creating much trouble for Altria, given the fall in its stock price, and its underperformance of Reynolds by about 13%,  since March. However, there might be a silver lining here.

The U.S. tobacco industry is highly consolidated, with three main players dominating the industry, viz. Altria (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO). Of these, Altria takes the leading position, with close to 47% of the market in smokable tobacco. However, this position seems slightly threatened since a merger between Reynolds and Lorillard was given regulatory approval by the Federal Trade Commission (FTC) last month. Apart from making the post-merger Reynolds a stronger competitive force, the deal is expected to give the company a clear win in the menthol market with Lorillard’s Newport (No.1 menthol brand) in its portfolio. Although this news has had an impact on Altria’s stock, it could hold certain advantages for the company as well.

Source: Nasdaq

1. The U.S. tobacco industry is relatively mature and is already highly consolidated. Post the merger, the degree of consolidation is expected to increase further with the top 3 firms holding close to 91% of the market. At a time when the U.S. tobacco industry is entangled with regulatory issues and is seeing a declining market, further consolidation could only deter entry of new players, giving more pricing power to Altria to help maintain revenues.

2. While a post-merger Reynolds could threaten Altria’s hold in smokable tobacco, Altria could still win in the promising e-cigarette category since the merger saw the divestiture of the Blu e-cigarette brand to Imperial Tobacco, who are less experienced in the U.S. tobacco industry. The brand may no longer have the kind of advantage in terms of branding and distribution that it would have enjoyed under a force like Reynolds. In this respect, Altria’s MarkTen may be at an advantage, especially as the company continues to invest in the brand, as evidenced by the recent launch of MarkTen XL, with improved battery power. The value of electronic cigarette sales has been doubling on a year on year basis, from $20 million in 2008 to around $1.5 billion in 2014, and Altria can be seen leveraging this opportunity.

Source: Research and Markets

3. Finally, the Reynolds-Lorillard deal is essentially about “menthol,” given that the post-merger entity will now have America’s No.1, Newport, and No.3, Camel, in its portfolio. However, this aspect continues to remain vulnerable to a ban on the product, with the FDA finding evidence of higher dependency among adolescents and higher usage among African-Americans, resulting in a disproportionate harm to the group. Given Altria’s prominence in the non-menthol category, it may be less affected of all the companies in case of such a development. With the leader in regular cigarettes, Marlboro, in their portfolio, the company could benefit, as former menthol smokers increasingly switch over to regular cigarettes.

• What Does The Reynolds-Lorillard Deal Mean For Altria? 
• Will Menthol Cigarettes Become Uncool In the U.S.? 
• What Would A Ban On Menthol Cigarettes Mean For Altria? 
• Trefis analysis: Altria retail share in the number of cigarettes sold in the U.S. 
• Trefis analysis: Altria number of cigarettes sold in the U.S. 
• Trefis analysis: Altria revenue per unit smokable product