RJ Reynolds: A Fine Company

By,By,

Michael Weiss

January 30, 2001

Overview of RJ Reynolds (RJR)

• Second-largest US

Tobacco company, with a

25% domestic market

share.share.

• Brands include Winston,

Camel, Salem, and Doral.

• Formerly known as RJR

Nabisco, but Nabisco was

sold to Phillip Morris in

June, 1999.

The US Cigarette Industry

• 45.1M adult smokers

• Market trend moving

towards higher-end,

full-priced cigarettes full-priced cigarettes

(75% in 2000)

• Average price doubled

since 1994, but sales

growth remained

steady.

The US Cigarette Industry (cont.)

• Al Gore says 3,000

kids start smoking

every day. That’s

good for business!good for business!

• The nature of the

market indicates a

strong, continuous

demand for the

product.

Cigarette Legal Issues

• With November, 1998

Master Settlement

Agreement (MSA),

tobacco companies are tobacco companies are

now protected in 46

states.

• Price increases to pay

the settlement have not

hurt sales or profits.

Cigarette Legal Issues (cont.)

• RJR investor relations

says the worst of legal

problems is long since

over.over.

• Yet Margaret

Stancampiano of

Merrill Lynch claims

“legal clouds will

continue to follow.”

What Makes RJR Special?

• RJR has an edge in product development, with ECLIPSE cigarette which heats rather than burns tobacco, thus reducing tobacco, thus reducing secondhand smoke and other health effects.

• RJR has a focus unique among tobacco companies on the US cigarette industry.

What Else Makes RJR Special?

• Considered to have the

most advanced

manufacturing plants in

the industry.the industry.

• It’s important to note that

cigarettes are essentially a

commodity, so any

particular differences

between manufacturers are

of marginal importance.

RJR’s Products

• Exclusively cigarettes, principally including

Winston, Camel, Salem, and Doral, but also

lower-priced brands such as Monarch.lower-priced brands such as Monarch.

• A local convenience store worker said

Camels and Winstons are selling just fine.

RJR Management

• Chairman and CEO

Andrew Schindler, 56.

• MBA from Wharton

• Started with RJR in 1974, • Started with RJR in 1974,

has led management

development, and Nabisco

manufacturing, among

other posts.

• CEO since 1994.

Other Management

• CFO since 1991 is Kenneth Lapiejko, 51.

• Exec. VP and General Counsel (they need

it) Charles Blixt, 48.it) Charles Blixt, 48.

• Exec. VP of Sales James Maguire, 48.

• Exec. VP-Marketing Lynn Beasley, 42.

Financial Highlights

• Sales of $8.2B, Net Income of $404M.

• EPS is $3.97, growing at 17% p.a.

• Currently has $1.2B in cash on balance sheet.• Currently has $1.2B in cash on balance sheet.

• PEG for December 2001 is 1.13

RJR as a Stock

• RJR has a book value of $7.1B, versus a market

capitalization of $5.3B.

• P/E ratio of 15, slightly higher than industry

average of around 12.average of around 12.

• Annual dividends paid are $3.10/sh, a dividend

yield of 6%.

• Earnings growth is predicted to be 13%, above

industry average of 10%.

RJR’s Performance

• RJR has done extremely well

over the past year, due partly to

the NASDAQ crash. It is at 51,

up from 17 in May 2000.

Drawbacks to RJR

• Yikes! The stock is at a high.

• Analysts say the cigarette market will begin to shrink in

the coming years; if this is so, RJR exposure puts it in the

worst position.worst position.

• RJR’s position as a high-income, Old Economy stalwart

means that its stock price is greatly subject to the dynamics

of other market sectors.

On the other hand…

• The stock is still below book value, and earnings

are still very strong.

• The worst of legal problems are over, yet RJR’s

price arguably remains cheaply valued due to the price arguably remains cheaply valued due to the

low expectations generally held on tobacco stocks.

• Dependable dividend payouts and predictability

make it a good portfolio stabilizer.

The Verdict

• RJR looks like the best

deal in the tobacco

industry, but that stock

price will make price will make

anybody think twice.