Tobacco Firms Maintain Fat Profits Through Higher Prices

Altria Group Inc (NYSE:MO) and Reynolds American Inc (NYSE:RAI) have raised the prices of their cigarette packs by six cents. This is the first round of price hikes implemented this year. The tobacco companies raised the prices of cigarettes twice last year, the second of which was in December 2011. The move is yet to be matched by Lorillard, which has decided to let the prices remain unchanged for now. The six cents hike works out to be an increase of 1.5% for Marlboro, which represents 87% of Altria’s volume. ^[1]

See our complete analysis of Altria stock here

Boost to Profitability

The excise taxes have been relatively stable of late so an increase in the retail prices will boost the profitability of tobacco companies. Price hikes are likely to continue in the future as well. Cigarette volumes have been declining as more consumers are aware of the repercussions of cigarette consumption. Hence, tobacco companies have resorted to raising their product prices periodically in order to maintain profitability. This is possible because cigarettes are known to exhibit low negative elasticity (i.e. a large price hike causes cigarette consumption to fall only slightly).

Besides cigarettes, Altria has decided to raise the prices of its Marlboro Snus by 5 cents, while Reynolds American is increasing the prices of its Camel Snus by 10 cents. Altria’s strong pricing in the recent past has led to some market share erosion but, overall, the picture looks good for the company as the volumes for smokeless tobacco products are growing at an annual rate of 4-5% and margins for this division have shown a constant improvement.

We have a $32.60 price estimate for Altria, which is slightly below the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. UPDATE: Altria, Reynolds Enacting First Price Increases This Year, wsj.com, June 14, 2012 [↩]