I N D U S T R Y N O T E
`M a y 1 5 , 2 0 1 8
`
`Michael S. Lavery
`Sr. Research Analyst, Piper Jaffray & Co.
`212 284-9511, michael.s.lavery@pjc.com
`Jeffrey L. Kratky
`Research Analyst, Piper Jaffray & Co.
`212 284-9551, jeffrey.l.kratky@pjc.com
`
`Related Companies:
`BATS LN
`IMB LN
`MO
`PM
`
`Share Price:
`38.27
`27.46
`54.52
`79.93
`
`Prices as of the close May 15, 2018
`INDUSTRY RISKS
`Unfavorable
`regulatory action, especially
`disruptive excise
`tax
`increases, growth
`in
`illicit trade, currency movements, and general
`macroeconomic erosion.
`
`Tobacco
`Latest US Scanner Data Show Improving Trends for Cigarettes, JUUL
`
`CONCLUSION
`Tobacco companies continue to enjoy strong pricing power, barriers to entry, and a
`favorable position with the retail trade. Recent IRI data show improving cigarette sales in
`the US. While it is early in 2Q18, cigarette volumes for the 4 weeks ended May 6th are
`running ahead of our expectations. JUUL continues to lead US vapor, and its momentum
`continued in the period as well. Imperial remains focused on vapor, and its recent myblu
`launch helped grow its vapor sales 16% since January; its myblu Intense launch is in July.
`
`• Altria's cigarette sales improve sequentially. Altria's total company measured retail
`sales increased 2.9% sequentially in the most recent 4 week period (through May 6th, vs.
`the 4 weeks ended April 8th). Its cigarette dollar sales increased 3.3% sequentially, and
`cigarette volumes increased 2% vs. the period ended April 8th. Compared to January,
`Altria's cigarette dollar sales are up 8.2% and volumes are up 6.5%. Year-over-year
`cigarette volume declines (down -4.5% in latest 4 weeks) also moderated from the prior
`4 weeks' pace (down -6.2%), suggesting Altria cigarette sales trends are improving and
`are currently running ahead of our 2Q18 estimate for a -6.5% decline.
`
`• Core Mark commentary suggest improving cigarette sales. Core Mark Holdings
`(CORE, not covered) is a large distributor to US convenience stores, and can offer helpful
`color on the retail environment for cigarettes. In its 1Q18 earnings call, Core Mark said
`that 1Q18 had overstated cigarette volume declines, partly from lapping the California
`tax increase, and will likely not be indicative of the full year. Core Mark said January
`experienced the steepest decline in cigarette carton sales, with each following month
`improving slightly, and it specifically called out Marlboro as having improved dramatically
`over the course of the quarter (excerpt from its call included inside note).
`
`• JUUL continues to grow over 20% sequentially. JUUL measured retail sales grew
`23% sequentially in the latest 4-week period, and it remains the clear leader in US vapor
`(chart inside). Its device unit sales grew 12% sequentially and pod sales rose 26%,
`consistent with recent trends, though device sales tend to fluctuate more. It is difficult to
`measure JUUL's share of total tobacco with much precision, but we estimate its share
`could now be greater than 3% of cigarettes plus the stick equivalents of its refill pods.
`
`• BAT grew sales, also had sequential cigarette improvement. Reynolds American
`(BAT's US segment) had positive sales growth of 0.8% year-over-year in the most recent
`4 weeks, although this is a deceleration from average growth of 4.5% over the past 3
`years. Cigarette dollar sales improved 3.5% sequentially, while volumes increased 2%.
`Compared to January levels, RAI grew cigarette dollar sales 9.1% and volumes 7%,
`suggesting broad improvement across the US cigarette category during 1Q18.
`
`• Imperial's hopes for myblu likely rest on myblu Intense. Total blu brand vapor sales
`increased 5% in the latest 4 weeks, and are up 16% since the February launch of myblu.
`Despite early success of myblu, which has earned $6.8M in retail sales since launching,
`we believe its upcoming July launch of myblu Intense is likely the product to watch. myblu
`Intense uses nicotine salts, like JUUL, though consumer reception to taste and branding
`of myblu Intense remain wildcards.
`
`Piper Jaffray does and seeks to do business with companies covered in its research reports. As a result, investors should be aware
`that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only
`a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information,
`including an attestation under Regulation Analyst certification, found on pages 4 - 6 of this report or at the following site:
`http://www.piperjaffray.com/researchdisclosures.
`
`Page 1 of 6
`
`JLI Ex. 2039, Page 1 of 6
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`

`

`JUUL continues US
`vapor leadership
`
`JUUL is the leader in US vapor by a wide margin, with sequential monthly sales growth regularly
`over 20%. Imperial got a small lift from its myblu launch in February, but we expect it to have more
`optimism for its upcoming myblu Intense launch in July.
`
`
`Exhibit 1
`
`4-week retail sales in the US vapor market, Feb 2017 – May 2018
`
`
`I N D U S T R Y N O T E
`
`M a y 1 5 , 2 0 1 8
`
`
`
`
`
`
`
`Source: IRI, Piper Jaffray & Co
`
`
`In the Core Mark 1Q18 earnings call, CEO Thomas Perkins gave the following commentary on
`cigarette volumes in the Q&A section:
`
`“So just to kind of restate where we were year-to-date, we were at 4.9% decline and we saw
`same-store declines around 9%. But if you backed out the California impact, it was more like 7%.
`If you look at where we were at in April, our same-store declines were more like 3% so we see a
`pretty positive trend in same-store sales. And also if you look to things that are going on with
`Marlboro and other promotions, we've seen Marlboro I think, at one time, it was down 9% and has
`improved pretty dramatically from that as well. So I don't know where it's going to end up, but we
`think that the first quarter, especially since we're lapping the California tax was probably
`overstated from where we look for the balance of the year to be.”
`
`
`
`
`
`
`
`
`
`
`
`
`
`
`
`Page 2 of 6
`
` $100
`
` $90
`
` $80
`
` $70
`
` $60
`
` $50
`
` $40
`
` $30
`
` $20
`
` $10
`
` $-
`
`JUUL
`
`Vuse
`
`MarkTen
`
`blu
`
`Logic
`
`JLI Ex. 2039, Page 2 of 6
`
`

`

`I N D U S T R Y N O T E
`
`M a y 1 5 , 2 0 1 8
`
`
`
`Philip Morris
`International (PMI)
`
`Altria Group, Inc.
`(MO)
`
`Imperial Brands plc
`(IMB-LON)
`
`British American
`Tobacco (BATS-
`LON)
`
`
`We rate PM Overweight. Our target price of $105 applies a ~18x multiple to our 2019E EPS of
`$5.75. We expect PMI to deliver 9-10% three-year average organic sales growth and 11-12%
`average EPS growth. Risks: Unfavorable regulatory action, especially disruptive excise tax
`increases, a stronger US dollar and the growth of counterfeit products could pose a risk to upside
`to the shares.
`
`
`We rate MO Overweight. Our target price of $75 is ~17x our 2019E EPS of $4.39, above its
`current multiple on our 2018E EPS. We expect Altria to deliver 1-2% three-year average sales
`growth and 12-13% average EPS growth. Risks: Unfavorable regulatory action, disruptive excise
`tax increases, growth in counterfeit products, or unexpected competitor price cuts could negatively
`impact share price.
`
`
`We rate IMB LN Neutral. Our target price of £28 is ~10.5x our CY2019E EPS of £2.68. We expect
`Imperial to average 0-1% organic sales growth (fiscal year) and 0-1% compound annual EPS
`growth (fiscal year) from 2018-20. Risks: Disruptive excise taxes, macro pressure, and currency
`moves may pose risk to profits.
`
`
`We rate BATS LN Neutral. Our target price of £43 applies a ~14x multiple to our 2019E EPS of
`£3.09. We expect BATS to deliver 6-7% three-year average organic sales growth and 5-6%
`average EPS growth. Risks: Disruptive excise taxes, macro pressure, and currency moves may
`pose risks to profits.
`
`
`Page 3 of 6
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`JLI Ex. 2039, Page 3 of 6
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`

`

`IMPORTANT RESEARCH DISCLOSURES
`
`I N D U S T R Y N O T E
`M a y 1 5 , 2 0 1 8
`
`Page 4 of 6
`
`JLI Ex. 2039, Page 4 of 6
`
`

`

`I N D U S T R Y N O T E
`M a y 1 5 , 2 0 1 8
`
`Notes: The boxes on the Rating and Price Target History chart above indicate the date of the fundamental Equity Research Note, the rating and the price
`target. Each box represents a date on which an analyst made a change to a rating or price target, except for the first box, which may only represent the
`first Note written during the past three years.
`
`Legend:
`I: Initiating Coverage
`R: Resuming Coverage
`T: Transferring Coverage
`D: Discontinuing Coverage
`S: Suspending Coverage
`OW: Overweight
`N: Neutral
`UW: Underweight
`NA: Not Available
`UR: Under Review
`
`Rating
`BUY [OW]
`HOLD [N]
`SELL [UW]
`
`Distribution of Ratings/IB Services
`Piper Jaffray
`
`Count
`371
`228
`21
`
`Percent
`59.84
`36.77
`3.39
`
`IB Serv./Past 12 Mos.
` Count
`Percent
`23.72
`
`88
`7.89
`
`18
`
`0
`0.00
`
`
`Note: Distribution of Ratings/IB Services shows the number of companies currently covered by fundamental equity research in each rating category from
`which Piper Jaffray and its affiliates received compensation for investment banking services within the past 12 months. FINRA rules require disclosure
`of which ratings most closely correspond with "buy," "hold," and "sell" recommendations. Piper Jaffray ratings are not the equivalent of buy, hold or sell,
`but instead represent recommended relative weightings. Nevertheless, Overweight corresponds most closely with buy, Neutral with hold and Underweight
`with sell. See Stock Rating definitions below.
`
`Analyst Certification — Michael S. Lavery, Sr. Research Analyst
`The views expressed in this report accurately reflect my personal views about the subject company and the subject security. In addition, no part of my
`compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report.
`
`Piper Jaffray research analysts receive compensation that is based, in part, on overall firm revenues, which include investment banking revenues.
`
`Time of dissemination: 15 May 2018 18:50EDT.
`
`Page 5 of 6
`
`JLI Ex. 2039, Page 5 of 6
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`

`

`I N D U S T R Y N O T E
`M a y 1 5 , 2 0 1 8
`
`Research Disclosures
`Piper Jaffray usually provides bids and offers for the securities of British American Tobacco plc and will, from time to time, buy and sell British American
`Tobacco plc securities on a principal basis.
`Piper Jaffray usually provides bids and offers for the securities of Imperial Brands plc and will, from time to time, buy and sell Imperial Brands plc securities
`on a principal basis.
`Piper Jaffray was making a market in the securities of Altria Group, Inc. at the time this research report was published. Piper Jaffray will buy and sell Altria
`Group, Inc. securities on a principal basis.
`Piper Jaffray was making a market in the securities of Philip Morris International Inc. at the time this research report was published. Piper Jaffray will buy
`and sell Philip Morris International Inc. securities on a principal basis.
`
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`
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`Stock Ratings: Piper Jaffray ratings are indicators of expected total return (price appreciation plus dividend) within the next 12 months. At times analysts
`may specify a different investment horizon or may include additional investment time horizons for specific stocks. Stock performance is measured
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`• Overweight (OW): Anticipated to outperform relative to the median of the group of stocks covered by the analyst.
`• Neutral (N): Anticipated to perform in line relative to the median of the group of stocks covered by the analyst.
`• Underweight (UW): Anticipated to underperform relative to the median of the group of stocks covered by the analyst.
`
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`
`Page 6 of 6
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`JLI Ex. 2039, Page 6 of 6
`
`