Reynolds American Downgraded By Goldman Sachs On Slipping Earnings Momentum

Goldman Sachs downgraded Reynolds American, Inc. RAI to Neutral on diminishing earnings momentum and full valuation.

The brokerage sees continued dip in industry volumes and estimates the company to incur higher settlement costs next year, which is expected to hurt EPS by 5 percent.

"We see fading earnings momentum for RAI as (1) US cigarette industry volume declines revert back to the historical rate of decline; (2) Deal synergies are likely to run out by end of 2016; and (3) RAI faces ~$250 million higher settlement costs (or 5 percent of EPS) in 2017," analyst Judy Hong wrote in a note.

On the volume front, Hong sees the U.S. cigarette industry volume decline reverting back to historical -2 percent to -4 percent levels as favoring trends of cheaper gas, wage growth, and benign excise taxes have started to fade.

"We see industry declines of 2 percent in the near term and closer to 3 percent in the out-years, with potential downside risk if Next Generation Products (NGP) gain more momentum," Hong continued.

Related Link: Pair Trade: Philip Morris Upgraded, Reynolds Downgraded At Goldman Sachs

The key driver of RAI earnings has been the deal synergies from the acquisition of Lorillard. The analyst expects the synergies to run out by year end 2016, and to be fully phased in by early-2017.

That said, Hong remains bullish on market share gain prospects of Newport and looks forward to the analyst day in November to get greater visibility into cost saving opportunities.

Meanwhile, RAI shares have gained 28 percent since being added to the Buy list on June 16, 2015, while SPX was up 1.5 percent. In addition, Hong's estimates are no longer above consensus.

Hong also cut the price target by $3 to $53, assumes 20X forward 12–24-month P/E, down from 21X on slowing EPS growth momentum, and an M&A value.

Shares of Reynolds American closed Friday's regular trading session down 5.38 percent to $47.15. In the pre-market hours Monday, the shares further lost 2 percent to trade at $46.20.

Full ratings data available on Benzinga Pro.