Equity Research – Wells Fargo Securities, LLC
- Wholesalers Continue to Build Inventory in November – Bodes Well for Q4 Volume Trends – We have heard from several of our tobacco wholesaler contacts that cigarette inventory is running very high this month. It appears wholesalers continue to build inventory positions in anticipation of a cigarette list price increase, which we believe will occur during the week of December 10, led by PM USA, of around $0.06-$0.07/pack. We believe this bodes well for industry volume trends in Q4. Therefore, we have further conviction industry top line will improve during Q4 driven by stronger volume trends, higher list prices, and easing promotional spending. We maintain our above-consensus Q4 EPS estimates for both MO and LO of $0.56 and $2.32.
- Pricing Concerns Overdone – Industry Healthier Today than Ever – Coming out of Q3 earnings, investors have been concerned about deceleration in cigarette net price realization. Based on our recent ”Tobacco Talk” survey results, we expect cigarette net price realization will accelerate in FY2013. We anticipate industry net price realization of +4% in 2013, up from ~+3% in 2012. Bottom line – we expect net price realization to accelerate in 2013.
- Valuations Look Compelling; MO Remains Top U.S. Tobacco Stock Pick – We believe MO and LO will see net price realization in-line with or better than the industry next year. MO is poised to remain a strong, very profitable industry leader with continued benefits from its stepped-up innovation. In terms of Lorillard, we see several positive catalysts on the horizon including: (1) potential increased transparency including better guidance and breaking out blu’s financial results; (2) potential FDA approval of LO’s new products; (3) possible combination with another tobacco company; (4) possible accelerated share repurchase; and (5) LO’s upcoming 3-for-1 stock split. We maintain our Outperform rating on both stocks and believe the recent relative underperformance of MO and LO vs. the S&P over the past 90 days provides attractive entry points on both.
Beverage, Tobacco & Consumer Research
Wells Fargo Securities, LLC
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New York, NY 10152
Phone: (212) 214-5051
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