Will E-Cigarettes Be The Knight In Shining Armor For U.S. Tobacco Stocks?

At a time when cigarette volumes in the U.S. have constantly been on the decline, tobacco giants such as Altria (NYSE:MO) have turned to new avenues of countering a declining market. One of these, is the budding electronic cigarette market, which has elicited much optimism in terms of opportunity among tobacco makers, investors, and industry analysts. However, e-cigarettes may be limited to being a tool for some degree of “damage control” rather than a fruitful opportunity for tobacco makers and here’s why:

Smokable products volume in the U.S. is estimated using data on Altria’s retail share and shipment volumes in smokable products, data for which is taken from the company’s 10-K.

— Let’s start by comparing the fall in the tobacco market vis-a-vis the rise in e-cigarette use in the U.S. Since 2009, volume sales of smokable products have constantly declined at a 3-6% rate. Even going forward, we anticipate an approximate 3% fall in year-on-year volumes to continue. At the same time, e-cigarette use has been increasing and is projected to grow. The value of electronic cigarette sales has been doubling each year, 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. ^[1] But how lucrative is this for Altria? Probably only to an extent. For one, e-cigarettes are predominantly used by prior smokers in an attempt to quit traditional smoking. It gives them the hit of nicotine, without exposing the smoker to other carcinogenic agents including tobacco. In this case, e-cigarettes are hardly a new revenue stream, but just one that could offset the losses from a declining cigarette market. Furthermore, many ex-smokers could choose to just quit smoking without e-cigarettes or opt for other products such as nicotine patches or lozenges, in which case, e-cigarettes may not even offset the entire decline coming from the regular cigarette realm.

— One major factor that might be troublesome for health advocates but a boon for tobacco houses is that e-cigarettes are adopted predominantly by ex-smokers, but not entirely by ex-smokers, i.e. there is evidence of a certain proportion of the population that smokes e-cigarettes recreationally without having smoked regular cigarettes before. Hence, there are some who use the product solely for the flavors and the feel that it offers, rather than in an attempt to kick the butt. In this case, e-cigarettes may just seem to create the much needed opportunity for volume increases for tobacco companies. However, this proportion of individuals is very meager. According to a study by Medicines and Healthcare Products Regulatory Agency (MHRA), less than 1% of e-cigarette users did not smoke regular cigarettes before. ^[2] This, once again, indicates that e-cigarettes hardly present a new revenue generating opportunity for tobacco makers, but only act as an avenue to offset a part of the losses from declining cigarette volumes.

— Next, let’s look at the costs associated with e-cigarette and regular cigarette use. If e-cigarettes on average are more expensive, they could in fact make up for revenues lost from a declining number of smokers, even if only a proportion of them get on the “vape.” However, this is not the case. According to eCig One, an e-cigarette reviewer, taking the average price per pack to be $5.50, along with a consumption rate of a pack per day, annual costs associated with smoking is estimated at about $2,000. On the other hand, for the same amount of nicotine need, the annual cost of using e-cigarettes is estimated at about $800, including an initial starter kit and associated accessories required over the time frame. This is why tobacco makers often use the phrase “up to 80% cheaper than tobacco” to sell e-cigarettes to consumers. ^[3] Now, given that e-cigarette users are actually just a fraction of the declining cigarette market, and that e-cigarettes are considerably cheaper than regular tobacco, the avenue may not even be too lucrative from a revenue standpoint. In this case, e-cigarettes may never be able to completely offset revenue declines from consumers quitting cigarettes, which hardly makes them commercially lucrative for tobacco makers.

— Finally, there is the matter of regulation even in this realm. The e-cigarette market, which was free from any regulation until now, may come under the same level of scrutiny that the tobacco industry deals with. For one, the CDC will be introducing a new anti-smoking campaign that will also target e-cigarette manufacturers by denouncing “vapes” as a route to quitting cigarettes. Furthermore, studies regarding the increasing prevalence of e-cigarettes, and the consequences of this in terms of nicotine addiction and associated brain damage particularly among the youth, has renewed the interest of authorities, who now see the product as one that may deem regulatory control. 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 will prohibit sale of e-cigarettes to children under 18 years of age. ^[4]  The bigger blow for the industry, which could come in the future, could be restrictions on advertising the product to entirely put away e-cigarette ads from the public eye. As regulation picks up, the e-cigarette alternative may just cease to be one from which tobacco makers could offset the volume decline in regular cigarettes, but one that also starts seeing a similar kind of volume decline.

In a final note, it is important to understand why the e-cigarette phenomenon is important. In recent times, tobacco makers have generated much revenue growth predominantly from price hikes, as volumes continued to decline against increasing regulation and rising health consciousness. Often, price hikes actually work in the tobacco maker’s favor since demand for cigarettes tends to be relatively price inelastic in light of its addictive properties. At such a time, e-cigarettes may seem to be a promising avenue, where the market size has actually been increasing. However, while e-cigarettes might be one avenue to offset a part of the volume declines in regular cigarettes, it may not be accurate to be bullish on tobacco stocks relying on the e-cigarette phenomenon, since it may not be able to make up for the revenues lost from a declining cigarette market. In this situation, the key strength with tobacco makers like Altria could continue to lie in pricing rather than volumes, with e-cigarettes remaining only a temporary tool to make up for a portion of the losses.

We have a price estimate of roughly $46 for the Altria Group, which is lower than the current market price.

See Our Complete Analysis For Altria

See the links below for more information and analysis:

• Who Stands To Gain From The E-Cigarette Phenomenon?
• Will E-Cigarettes Be The Next Big Thing For Altria?
• Trefis analysis: Number of Cigarettes Sold in the U.S.
• Trefis analysis: Revenue Per Unit Smokable Product 

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More Trefis Research

1. Research and Markets: US E-Cigarette Market 2014-2018: Key Vendors are LOGIC Technology Development LLC, Lorillard Inc, NJOY & Vapor Corp [↩]
2. Safety Evaluation and risk assessment of electronic cigarettes as tobacco cigarette substitutes: a systematic review [↩]
3. How Much do E-cigarettes Cost? [↩]
4. E-cigarette industry has few rules, but change seems likely [↩]