Tobacco Tumult

A leading category takes beating in first-quarter 2008

Published in CSP Daily News

By  Angel Abcede, Senior Editor/Content Development Coordinator

NEW YORK -- A rough first quarter, looming federal regulation and the pending spinoff of a major industry player top the list of highlights from the tobacco segment, according to analyst Nik Modi, who presented a category update during a CSPNetwork CyberConference held Thursday. "Tobacco overall had a bad first quarter [for 2008]," Modi said, "but it was bad for just about every category in the c-store." [For an On-Demand Replay of the CyberConference, click here (free to retailers and wholesalers; $49 others).][image-nocss]

Covering a wide range of topics, Modi, an analyst with New York City-based UBS Investment Research, centered on four unfolding developments:

A difficult first quarter for the category, but indications of improvement in the second. Resilience of moist-smokeless tobacco (MST) even in a tough economy. The impact of potential FDA regulation. Prospects for New York City-based Lorillard in its upcoming spinoff.

The first quarter of 2008 was simply "bad" for the segment, Modi said, with industry volume down 3% to 4%. Richmond, Va.-based Philip Morris USA was down 1.2% in the quarter, while Winston-Salem, N.C.-based R.J. Reynolds took a hit with a 12% drop. Overall, stocks within the segment dropped 7% (representing $5.3 billion), he said.

Still, in the face of declining volumes, cigarette manufacturers, according to Modi, are feeling the heat from stockholders and are moving to cut promotional incentives and raise prices. "Prices are up even through volume is down," he said. "The drivers are shareholder return and [pressure] from the investment community."

And yet despite rising costs both at the gasoline pump and in the store, consumers appear to be moving back toward former spending habits. Numbers for April and May, Modi said, reveal significant improvement over March. One of the reasons could lie in consumer expectation. Citing a University of Michigan study, Modi said consumers expect average price increases of 3% to 4% to occur every year for the next five to 10 years.

"That expectation is important," he said, "because it means that sensitivity to price increases may not be so bad."

One of the subcategories supporting tobacco is MST, up a healthy 7%. In addition, premium brands showed a 2% growth in volume. Possible explanations lie in how consumers who opt to smoke less due to increasing prices, turn around and decide to move to premium to get the best bang for their shrinking buck. The growing pervasiveness of smoking restrictions and a strong consumer base of younger (18 to 34-year-olds) demographic all bode well for MST. Comparing what consumers would spend on a can of Copenhagen vs. smoking Marlboros for a week, the difference was about half (about $15 vs. $30), Modi said.

Turning the discussion to other related topics, Modi examined the pros and cons of federal oversight coming from the Food & Drug Administration (FDA). On the negative side, retailers would likely have to reconfigure displays and the back-bar area, as well as be exposed to differing regulations going state by state.

On the plus side, Modi believes such regulation would spark innovation and help manufacturers create products they could claim to be "reduced risk." Such claims can be invaluable tools to marketing new products.

Finally, Modi directed the discussion to Lorillard Tobacco Co. and its proposed spinoff from its parent, Loews Corp., New York. With a dominant menthol brand in Newport, numerous scenarios are open for Lorillard, Modi said. Among the potential outcomes are its purchase by one of the larger cigarette manufactures or the creation of partnerships among midsized players.

"Or [Lorillard] could continue to operate as a 'standalone' and turn Newport into a 15%-share brand [from 10%] over the next 10 years," he said.

By Angel Abcede, Senior Editor/Content Development Coordinator
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