Morgan Stanley's 2015 Outlook For Big Tobacco

Analysts at Morgan Stanley recently took an in-depth look at what 2015 will bring for the tobacco industry.
Quota buyout expiration
Since the institution of the Fair and Equitable Tobacco Reform Act of 2004, the federal tobacco quote and price support system has been replaced by an industry-funded buyout of tobacco growers and quota holders. The resulting decade of buyouts has cost the tobacco industry about $10 billion, but the buyouts came to an end in 2014.
Starting in 2015, the elimination of buyout payments will reduce annual operating costs at Altria Group Inc MO by about $300 million, at Reynolds American Inc RAI by about $160 million and at Lorillard Tobacco Company LO by about $95 million.
Where will the savings go?
Morgan Stanley analysts see four possible uses for the savings that will result from the end of the buyout:
1. Increase volumes by cutting costs
2. Realize an up to five percent boost in 2015 earnings
3. Invest further in the development of e-cigarettes and other technologies
4. Utilize greater operational flexibility to achieve accretion targets
Outlook
Overall Morgan Stanley analyst Matthew Grainger is cautious on tobacco stocks in 2015. “With valuation at peak levels (~ 12.2x 2015e EV/EBITDA), we view the sector as effectively priced for perfection, and we argue that a more nuanced earnings delivery could weigh somewhat on sentiment.”
Catalysts
Analysts will turn to Altria and Reynolds’ 2015 earnings forecast as an early indicator of the companies’ expectations for quota buyout savings. In addition, Altria’s Phillip Morris USA is expected to announce formal pricing action in the second quarter of 2015.