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Strong Segment Growth Helps RAI’s 1Q16 Operating Margin

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Operating income

Reynolds American’s (RAI) reported operating income increased by 786.3% to ~$6.1 billion in 1Q16 versus $0.7 billion in 1Q15. This includes charges for implementation costs, asset impairment, and exit costs. It also includes transaction-related and financing costs for the Lorillard acquisition and related divestitures to Imperial Tobacco Group (ITYBY), as well as other litigation charges.

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Adjusted operating income

Excluding the above charges, RAI’s adjusted operating income increased by 72.4% to $0.72 billion in 1Q16 compared to $0.46 billion in 1Q15. The operating income increased primarily due to strong results delivered by RJR Tobacco’s new addition of Newport brand, RJR Vapor’s Vuse Digital Vapor Cigarette, and American Snuff’s Grizzly brand.

Operating margin versus peers

As a result, RJR Tobacco’s adjusted operating margin increased by 6.4% to 46.5% in 1Q16. Santa Fe’s operating margin increased to 56.4% while American Snuff’s operating margin increased to 61.3% in 4Q15.

RAI’s 1Q16 adjusted operating margin increased by 8% to more than 45%, while its reported operating margin increased to 211.6% in 1Q16.

However, Altria Group’s (MO) 1Q16 operating margin fell by 2 basis points to ~43.6% in 1Q16. The impact on the operating margin was due to higher pricing, volume, and the benefit of the federal tobacco quota buyout expiration, offset by lower volumes. Similarly, Philip Morris International’s (PM) 1Q16 operating margin fell by 2.8% to 41.9% due to lower adjusted operating income mainly due to EEMA and Asia.

Cash tender and higher profit margins

RAI completed a cash tender offer and redemption of $3.6 billion for its outstanding notes. This reduced the company’s level of outstanding debt. RAI expects to reach the top end of its target leverage of 2.5x debt-to-EBITDA by the end of this year. In 1Q16, the company had a cash balance of $4.4 billion.

RAI plans to strengthen American Snuff’s moist snuff products, as profit margins on moist snuff products are higher than on cigarette products.

RAI makes 0.2% of the iShares Russell 3000 ETF (IWV).

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