Big Three's E-Cig Play

With cash at ready, Altria, Reynolds, Lorillard to increase investments, Herzog tells NATO

Published in CSP Daily News

By  Mitch Morrison, Vice President & Group Editor

Bonnie Herzog

LAS VEGAS -- Tobacco's Big Three are primed to leverage their increased investment in the burgeoning electronic cigarette and e-vapor markets.

On the surface, it may seem jarring the attention Lorillard, Reynolds American and Altria are investing in the e-vapor market even at the expense of these companies' lucrative combustible businesses. But Wells Fargo analyst Bonnie Herzog shared with retailers at the NATO Show in Las Vegas on Thursday that there are compelling reasons for this shift.

While cigarette hallmarks Newport, Camel and Marlboro, respectively, remain the bulwark of these tobacco giants' portfolios, long-term financial incentives and transitioning consumer preference strongly suggest these companies place a strong footing in the nascent electronic puffing sector.

In short, the Big Three don't want to make the mistake committed by Coca-Cola and Pepsi, which were slow to embrace energy drinks and failed to crack the lock currently controlled by such powers as Monster and Red Bull.

Additionally, the Big Tobacco entities are soon to reap large stockpiles of cash, including $1 billion each with this year's expiration of the 10-year-old Tobacco Transition Payment Program, better known as the tobacco buyout legislation signed by President George W. Bush in 2004 that ended Depression-era tobacco quotas on farmers.

And then there is the 1998 Tobacco Master Settlement Agreement (MSA), in which the major manufacturers pay the states an annual fee based on the amount of cigarettes sold. As cigarette consumption declines, so do the MSA payments.

With that, Herzog noted a strong incentive for the Big Three to aggressively promote e-cigarettes and its e-extensions to overtake cigarettes over the next decade.

"The big manufacturers really have a huge competitive advantage here," Herzog said, underscoring the financial windfall as fresh funds they could funnel into their e-businesses.

To date, Lorillard stands out among the Big Three in the e-tobacco world. Two years after the company's acquisition of blu, the e-cig brand ranks No. 1 in brick-and-mortar sales, according to Nielsen, outpacing its nearest rivals, Logic and NJOY combined.

That said, e-cigs--or e-vapors as Herzog now describes them to expand the definition to vaping, tanks and mods--are in their relative infancy, representing approximately 1% of total tobacco share. And Herzog, who is on record predicting electronic puffs [all e-vapor] will exceed combustible cigarette sales within a decade, expects Reynolds and Altria to rapidly grow market share as they launch their e-cig brands, Vuse and MarkTen, nationwide this year.

What effect will the Big Three have on the Logics and NJOYs and even the next tier of players like Fin, V2 and Mistic? "[They] could catapult the growth of this category," said Herzog, predicting accelerated growth, pending U.S. Food & Drug Administration (FDA) regulations of the electronic tobacco segment.

Herzog covered a number of other topics, including:

  • Reynolds' rumored takeover of Lorillard: "My phone was off the hook for two-plus days" when The Financial Times broke the story, Herzog said. At first glance, Herzog doubted such prospects, but now she says such a marriage is 80% likely. What will probably determine whether such a deal occurs are the divestitures the Federal Trade Commission (FTC) is likely to require. "That's the biggest risk to this [deal]."
  • Electronic cigarettes: Herzog noted the total e-vaping retail industry has topped $2.2 billion (online sales included), and that what began as a cig-alike concept has rapidly morphed into new puffing technologies. How FDA chooses to regulate this rapidly expanding sector will likely determine the shape and direction of this craze.
  • Cigarettes: Expect the Big Three to take a six-cents-per-pack increase by the first week of June. Herzog said that she expects the size of such increases to decline over the coming years as a growing percentage of their total margins emanates from e-products and the end of the tobacco buyout payments.
  • Other tobacco products: Herzog said OTP remains a very steady segment, growing about 5% annually, and she cited Grizzly as a smokeless brand that continues to grow share and value.
By Mitch Morrison, Vice President & Group Editor
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