NATO Show 2014: Big 3’s E-Cig Play

Altria, Reynolds, Lorillard to increase investments, Herzog says

By  Mitch Morrison, Vice President & Group Editor

Wells Fargo’s Bonnie Herzog predicts e-cig sales will eclipse sales of combustibles within a decade.
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Tobacco’s Big 3 are primed to leverage their increased investment in the burgeoning e-cigarette/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 show that there are compelling reasons for this shift.

While Newport, Camel and Marlboro, respectively, remain the backbones of these tobacco giants’ portfolios, long-term financial incentives and transitioning consumer preference suggest these companies get a strong footing in the electronic sector.

Also, 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 pointed out a strong incentive for the Big 3 to aggressively promote e-cigarettes and their extension to overtake cigarettes over the next decade.

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

To date, Lorillard stands tall among the Big 3 in the e-tobacco world. Two years after its acquisition of blu, the e-cig brand ranks No. 1 in brick-and-mortar sales, outpacing its nearest rivals, Logic and NJOY combined.

That said, e-cigs—or e-vapors, as Herzog now refers to the expanding category, including vaping, tanks and mods—are in their relative infancy, representing about 1% of total tobacco share. And Herzog, who has predicted electronic will exceed combustible sales within a decade, expects Reynolds and Altria to rapidly grow market share as they launch their e-cig brands, Vuse and Mark Ten, nationwide this year.

What effect will the Big 3 have on the Logics and NJOYs and even the next tier of players, such as Fin, V2 and Mistic? “[They] could catapult the growth of this category,” said Herzog, predicting accelerated growth, pending FDA regulation.

Beyond the Investments

Herzog covered a number of other topics:

 ▶ 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 says the marriage is 80% likely. What likely will determine whether the deal occurs are the divestitures the FTC is likely to require.

 ▶ Electronic Cigarettes: The total e-vaping retail industry has topped $2.2 billion (online sales included), Herzog said, and what began as a cig-alike concept has rapidly morphed into new technologies. How FDA chooses to regulate this rapidly expanding sector will likely determine the shape and direction of this craze.

 ▶ Cigarettes: Expect the Big 3 to take a 6-cent-per-pack increase by the first week of June. Herzog expects the size of such increases to decline over the coming years as a growing percent of their total margins emanates from e-products and the end of tobacco buyout payments.

 ▶ OTP: It remains a very steady segment, growing about 5% annually, she said. She cited Grizzly as a smokeless brand that continues to grow share and value.

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