Who Stands To Gain From The E-Cigarette Phenomenon?

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Tobacco companies in the U.S. have been seeing tougher days off late, where increasing health consciousness, coupled with anti-smoking policies, have resulted in dwindling volumes. The total volumes sales of smokable products in the U.S. has witnessed an almost 20% decline since 2009, and is projected to continue falling going forward. Given these circumstances, most tobacco houses have sought to use price hikes to maintain revenues and profits. However, this strategy may be constrained beyond a point, since further price hikes could only exacerbate the volume decline. In this situation, one promising avenue that may be at tobacco makers’ disposal are e-cigarettes.

An electronic cigarette, or an e-cigarette, is a battery-powered device that produces an effect similar to that of smoking a tobacco cigarette. While e-cigarettes are free of tobacco, users exhale vapors that contain organic compounds, heavy metals, and nicotine. The reasons for use usually involve quitting traditional cigarettes and for recreational purposes. [1] According to a recent report by the Center for Disease Control and Prevention (CDC), an 18% drop in the incidence of tobacco smoking has been more than offset by a rise in e-cigarette use. [2] Furthermore, the value of electronic cigarette sales has been doubling on a year on year basis, from $20 million in 2008 to around $1.5 billion in 2014, and is projected to continue growing at over 20% year-on-year going forward. According to Wells Fargo, e-cigarette sales could overtake cigarette sales in the U.S. by 2020, which makes it a very important category for players in the tobacco industry. [3] Given this, we give you some insight into prospects of this category for big tobacco houses in the U.S.

e-cig

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Source: Research and Markets

Let’s start with Altria (NYSE:MO), the maker of Marlboro cigarettes, and the leader in the U.S. tobacco industry. While the company does not have a very prominent presence in the e-cigarette market, they have taken a number of steps to leverage the opportunity present in this avenue. In February 2014, Altria’s subsidiary, Nu Mark, signed a $110 million deal to acquire the e-cigarette business of Green Smoke Inc. Later in the year, the subsidiary completed the national roll-out of the MarkTen, which was supposed to be a notch above the 200 types of e-cigarettes already available. Although the brand presently controls a meager share of the market and has seen some difficulty gaining traction, it is poised to see growth as the company continues to invest in the brand. For instance, apart from releasing new flavors, Altria came out with the MarkTenXL that has superior battery power in comparison to the MarkTen. Furthermore, given the bright prospects in the e-cigarette domain, Altria could have the motivation and the means to buy smaller e-cigarette competitors to stand their ground in the market. Given this, the company could see increasing market share from about 6.1% presently.

See Our Complete Analysis For Altria

Next, let’s look at Reynolds American (NYSE:RAI), the number two tobacco company in the U.S. with close to 28% of the market. This year, Reynolds American will be seen collaborating with the U.S. number three Lorillard (NYSE:LO), after the FTC gave regulatory approval for their proposed merger last month. [4] When it comes to e-cigarettes, Reynolds has the leader Vuse in their portfolio. After the national roll-out of the product in 2014, Vuse immediately gained popularity to account for over 35% of the market a year later. This is evident when one looks at the company’s sales in all the other categories, which grew a phenomenal 37.7% year-over year in 2014. [5] Vuse is expected to further gain traction going forward, especially as the brand benefits from further distribution and marketing synergies that come with a merger with Lorillard, another experienced player in the e-cigarette realm.

Lorillard formerly owned America’s number two e-cigarette brand, Blu, which will be divested to Imperial Tobacco (NYSE:ITY) in an attempt to mitigate anti-trust issues related to the merger. Although the brand had a strong 22.7% market share, its share has been declining since 2013 over lower sales. Given this, a divestiture of the brand to Imperial Tobacco, who happens to be relatively inexperienced in the U.S., may not bode well for the brand. In particular, the likes of Altria and Reynolds are bound to have more efficient distribution networks and marketing muscle, the lack of which could further hamper sales of the brand going forward. Furthermore, since e-cigarettes are predominantly used by former smokers, those dominating the market for cigarettes stand to gain as individuals may choose an e-cigarette brand from the same company’s portfolio. In this case also, Imperial could lose share to Altria and Reynolds, who already have a large consumer base.

In spite of the bright prospects that e-cigarettes present, a number of factors may hamper prospects for tobacco companies. For one, the e-cigarette market, which until now was devoid of any regulation, may come under the same level of scrutiny that the tobacco industry deals with. The CDC recently announced the introduction of a new anti-smoking campaign that will also target e-cigarette manufacturers by predominantly denouncing “vapes” as a route to quitting cigarettes. Furthermore, studies regarding the penetration of e-cigarettes among the youth, and the consequences of this, has renewed interest of regulators, who now see the product as one that they may deem to gain regulatory control. In this respect, the acting head of the Food and Drug Administration (FDA) said that the agency will bring in regulations around e-cigarette use, as early as this year. As of now, the FDA requires e-cigarette makers to register with the agency, report ingredients, submit new products for review, and provide evidence regarding any health risks and benefits of the products. Under the new rule, the FDA is expected to prohibit sale of e-cigarettes to children under 18 years of age. The bigger blow for the industry, which could come in the future, could be restrictions on advertising the product, which could entirely put away e-cigarette ads from the public eye.

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Notes:
  1. Will E-Cigarettes Be The Next Big Thing For Altria? []
  2. E-cigarette use triples among middle and high school students in just one year []
  3. Imperial Tobacco to snag U.S. e-cigarette lead thanks to deal []
  4. What Does The Reynolds-Lorillard Deal Mean For Altria? []
  5. Reynolds American Inc. 10-K, SEC []