Could OTP Overtake Cigarettes?

Industry execs weigh in on tobacco during CSP CyberConference

Published in Tobacco E-News

By  Linda Abu-Shalback Zid, Senior Editor

OAK BROOK, Ill. --  Nik Modi, analyst at UBS Securities LLC, New York, isn’t shy about his predictions for the tobacco industry. During CSP's Tobacco Update CyberConference on December 7, sponsored by Swedish Match, for example, he predicted that cigarette prices would go up before the end of December.

OAK BROOK, Ill. --  Nik Modi, analyst at UBS Securities LLC, New York, isn’t shy about predictions for the tobacco industry. During CSP's Tobacco Update CyberConference On December 7, sponsored by Swedish Match, for example, he predicted that cigarette prices would go up before the end of December.

Later that same day, Philip Morris USA Inc. announced a five-cent-per-pack increase, which was followed by a five-cent increase at Reynolds American Inc. and a six-cent increase at Lorillard Inc.

Modi also predicted during the CyberConference that other tobacco products (OTP) will go from 10% of the tobacco category's profit pool to 30% by 2015, and even overtake cigarettes for 55% of the category by 2025.

"People often say, 'No, that's not possible; cigarettes are huge," Modi said. But he points out that the industry had been there in 1940, and that smoking restrictions could continue to drive consumers to smokeless products.

Whether that prediction comes true or not, it's clear from the presentations from both Modi and Joe Teller, director of category management at Swedish Match North America, that OTP warrants continued retailer attention.

Teller focused on cigars, which account for 47% of total OTP unit volume and are an "extremely competitive" business. He suggested retailers engage in clustering to "tease out meaningful differences" in which items sell best at the item, state or store market level. "I think we're all looking for an edge in cigars and we've got to keep this business moving--and I think this holds a lot of promise."

He added, "These guys who buy cigars visit c-stores more often than the buyers of any other category inside the store, including cigarette shoppers and [moist smokeless tobacco] dippers, so the importance of the shopper can't be overstated."

When it comes to smokeless products, Modi addressed the issue of relative risk of tobacco products. In Sweden, for example, where reduced risk can be communicated, smokeless accounts for 70% of the consumption in the tobacco category. "Could a similar thing happen here? Certainly, it won’t happen overnight, but it’s going to happen over time, in my view."

He said that if the U.S. Food & Drug Administration (FDA) allows for relative-risk communication, "labeling on the products might even change to instead of 'this product may cause mouth cancer' to 'this product is less bad for you than cigarettes,' or along those lines."

Meanwhile, states like Kentucky and Indiana already have signed bills that say taxes should coincide with harm. "It’s an interesting dynamic, and I don’t think people are paying enough attention to this whole reduced-risk debate that’s going on. But it could literally change the dynamics of this industry at the back bar in a very short amount of time."

In addition to OTP talk, Modi also addressed some issues affecting cigarettes.

He said there has been a "significant increase" in the discount segment since the federal excise tax increase in 2009 coincided with the recession. He said the Big Three now "own" the discount category, with more than 50% overall share of that category. "There's still a lot of concern about discount gaining share and what that means for premium pricing, because the big three are actually participating in it this time, unlike the last several times."

Modi also discussed an unusual 10-cent state cigarette tax reduction in New Hampshire, with the state planning another 10 cents next year. After four months, the tax brought in $77.5 million, which was $3.5 million less than expected. But, he said, it’s too soon to tell what the full outcome will be. "I think December will be a very, very important month, when it comes to understanding exactly how effective this endeavor will be, and that I think will dictate what happens across a lot of other states." He said that other states have tried to pass similar reductions, unsuccessfully, and added, "But my sense is that this could more of a trend in the future."