Tobacco Overview 2013

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Under Evolution

For all the uncertainty that could define the tobacco category in c-stores in 2013, there’s another buzzword retailers might want to consider: evolution.

Continuing declines in cigarette sales, the looming potential of big changes in tobacco regulation and the growth of other tobacco products (OTP) point to a fundamental shift in the category—and new opportunities, industry watchers say.

Wells Fargo analyst Bonnie Herzog envisions consumption evolving to the point at which consumers who enjoy nicotine embrace a variety of tobacco products in the same way they might embrace different beverages throughout the day.

“They might smoke a cigarette when they wake up,” she says. “As they’re driving, they may decide to use smokeless tobacco. And they might use an e-cigarette at the office.”

Lou Maiellano, president of TAZ Marketing and Consulting, says retailers have to be aware of unresolved regulatory issues that have steeped the category in uncertainty, but they shouldn’t let that become a focus or distraction.

“In some cases they end up poisoning your thought process,” he says. “And they are always going to be there.”

Regulatory Suspense

Retailers increasingly face a balancing act between cigarettes and OTP, says David Bishop, managing partner of Balvor, a Barrington, Ill.-based sales and marketing firm.

Even though OTP has experienced strong single-digit growth in the past decade, research shows less than one-third of retailers intend to expand OTP space this year, he says. That reluctance stems in part from concerns about taking space from cigarettes and the potential effect on retail contracts.

“The balancing act,” he says, “is complicated by the fact there’s a lot of money at risk when we talk about shuffling between those two major categories.”

Retailers also are cautious because no one knows when and how the U.S. Food and Drug Administration (FDA) will act on major regulatory proposals, including a ban on menthol cigarettes, harsher warning labels on smokeless tobacco and calls for more restrictions on e-cigarettes and flavored cigars. Pending state legislation also is acting as a lock on the “latent potential” of OTP, he says.

“What retailers want is some clarity and certainty,” Bishop says. While the right assortment of cigars and smokeless offers growth potential for c-stores, “some of these regulatory uncertainties could be game changers” for those segments.“If you’re a retailer in Massachusetts and they pass (local) legislation that restricts the selling of cigars in packs less than five, there goes the foil-pack business,” he says.

“If you’re in Vermont, and Vermont passes legislation that taxes e-cigarettes at 92% of the wholesale price, that business is gone tomorrow because it’s going to become more expensive to use that product as opposed to cigarettes.”The $52.5 billion that c-stores rang up in cigarette sales last year amounted to a 1.7% decline and 2% unit drop from the year before, according to SymphonyIRIdata Group. While the declines in cigarettes are expected to continue, Herzog of Wells Fargo points to “pockets of growth “such as Santa Fe’s Natural American Spirit brand, Newport menthol and Marlboro Special Blend. Premium brands are performing well, Bishop of Balvor says, in large part because of new brand pricing structures that feature significant discounts. Philip Morris, for example, offers the Marlboro brand at a premium price position, but it has made brand extensions available at discounts sometimes as high as 35%, he says.“That is really what is helping growth at business to the point where premium has grown market share on a unit-sales basis largely attributed to the new brand architecture,” he says. Herzog, who believes the FDA will opt against a ban on menthol, points out that these products are declining less rapidly than others, partly because of their appeal with certain demographics.“And you certainly have seen an increase in competitive activity from the manufacturers when it comes to menthol,” she says.

In Search of Value

Total c-store sales of smokeless hit $4.8 billion last year, a 5.6% increase, according to SymphonyIRI. “A lot of what is driving that growth is dual users and probably some new entrants to the category,” Herzog says.“More people are consuming smokeless, and I expect that growth rate to continue.”

Moist tobacco, says Maiellano of TAZ, has been fueled by value-seeking consumers.

“One of the biggest things that has taken place in the last year-and-a-half to two-and-a-half years is that the pricing on moist smokeless has drastically comedown,” he says.

 Retailers looking for continued growth opportunities in moist tobacco will want to take note of increased sales of portion pouches. The pouches drove two-thirds of the subcategory’s incremental growth last year, Bishop says. Snus sales were flat overall last year, but those figures don’t tell the whole story. The subcategory had its hits with R.J. Reynolds ‘Camel Snus and Swedish Match’s General, which has a small market share but in some stores now holds 25% of the snus business, Bishop says.             

Prepriced Opportunity

While many retailers are less than thrilled with Prepriced 99-cent packages of cigars, Bishop of Balvor says the foil pouches are driving unit growth in the category.

The Prepriced multipacks, he says, reflect a highly competitive pricing environment among cigar manufacturers, and the foil packets are drawing people to c-stores.

“Retailers who haven’t tried to take advantage of it out of concern it suppresses prices or deflates their dollar growth have recognized after the fact that the consumers are moving there, “Bishop says.

Smart E-Cigarettes

Expanded distribution and trials of e-cigarettes continue to fuel the category. And while Herzog of Wells Fargo says it’s reasonable to expect greater regulation of e-cigarettes, “I am quite bullish on the e-cigarette category as an opportunity to drive growth.”

She predicts the category will exceed $1 billion in revenue this year and that consumption of e-cigarettes will surpass that of traditional cigarettes within the next decade.

Technological advances are likely to bringe-cigarettes closer to a traditional smoking experience over time, she says.

Bishop of Balvor recommends retailers offer a selection of e-cigarette brands that take strength and flavor into consideration. And though disposables are critical for gaining entry into the category, offering e-cigarette kits can help c-stores increase rings.

Herzog suggests offering three to four key brands and a few up-and-coming e-cigarette brands. Giving e-cigarettes more space in the tobacco set is “smart and strategic, “she says, “because that category is giving you growth as well as margin.”

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