How will the No. 1 tobacco player respond to the Reynolds-Lorillard deal?
RICHMOND, Va. -- Coke and Pepsi, Anheuser-Busch and MillerCoors, Hershey and Mars.
Take the category and it’s easy to define the No. 1 and No. 2 players.
The cigarette industry once fielded such competition but in recent years, one tobacco manufacturer has easily stood above the rest--Altria.
That may soon change, analysts and experts say.
Pending federal approval, yesterday’s announced merger between Reynolds American and Lorillard creates a dramatically new dynamic in the tobacco space.
By adding Lorillard’s Newport line, which commands a 13% share of the U.S. market, Reynolds American (RAI) will represent 35% to 40% of the total cigarette market. At the same time, Imperial Tobacco, which is slated to pick up several of Reynolds’ second-tier brands, including Winston and Kool, plus Lorillard’s coveted No. 1 e-cig, blu, springs to the third largest tobacco player in the country, with an impressive cigarette/cigar/e-cig platform.
The question is obvious: How will Altria respond?
Altria, which holds roughly 50% U.S. market share lead by its super-power Marlboro line, declined to comment on the Reynolds-Lorillard merger and its implications to the Richmond, Va.-based company’s strategies.
The question was asked to RAI President and CEO Susan Cameron, who chuckled before offering a milquetoast response.
“This is a very competitive industry and of course one's always talking about what the competitor may or may not do,” she said during Tuesday’s news conference. “But I feel very confident that this iconic brand portfolio will compete very well with the industry leader, and that Imperial will compete very well in this marketplace.
“We have a great brand portfolio here, great demographics and we are committed to transforming this industry, as we've been committed for the last 10. So I look forward to the future and the competition will continue.”
Will C-Stores Benefit?
Analysts suggest any hit to Altria will be modest, if at all. While Reynolds becomes a stronger No. 2 and Imperial will boast a solid cross-tobacco platform, the elimination of Lorillard as the dominant menthol player leaves just two players controlling more than 85% of the U.S. cigarette market. Such dominance by two manufacturers could result in scaled-back promotions and marketing incentives.
“The combination will largely be a net neutral for Altria, as a more complex competitive environment for PM USA is offset by a moderating promotional environment over time,” says Nik Modi, tobacco analyst at RBC Capital Markets.
“Altria has had a significant advantage in the marketplace due to its sheer size,” Modi added in his report posted just days before yesterday’s merger. “With close to 50% of the total US cigarette market, having the most competitive pricing on Altria’s brands (especially Marlboro) has been key for many c-store retailers (who rely on cigarettes to drive foot traffic).
“…The combination of RAI and LO could lead to better shelf placement of the combined companies' brands, especially for national retail chains.”
In her note Tuesday, Wells Fargo senior tobacco analyst Bonnie Herzog cited what retailers see as a big win in the Reynolds deal. “A stronger No. 2 to go head-to-head with Altria,” boosted by greater resources and marketing support.
But, she added, retailers may also feel the squeeze borne from reduced competition among heavyweights. “Only two ‘powerful’ cigarette companies, which could result in stricter contracts and smaller players getting squeezed; (and) even lower retailer cig margins.”
It is possible the impact will be less than forecasted. Some suggest that while the names are changing, three tobacco manufacturers will continue to hold the lion’s share of market. Ratchet up RAI, replace Lorillard with Imperial Tobacco – and voila, not much has changed.
Ted Cooper, a writer for The Motley Fool, acknowledges the thinking but ultimately rejects it. Rather, he offers a different approach in which the new Big Three all win.
“Instead of competing head-to-head with Altria in the cigarette market, the new Reynolds American has a chance to exploit its dominant position in the menthol category. Altria may focus on traditional Marlboros while Reynolds American focuses on gaining share in the menthol category.”
The game-changer, he suggests, could be Imperial, which he says, “adds a meaningful competitor in the U.S.”
With Imperial to hold 10% share of the domestic market – comparable to Lorillard’s though with a broader portfolio – Cooper calls Imperial “the only company with sufficient scale to compete with Altria and Reynolds.”
Pending no surprises by the Federal Trade Commission, which must approve this complex transaction, Cooper is upbeat about the future of the total tobacco business. “The Reynolds-Lorillard merger is the most exciting thing to happen in the industry since the advent of e-cigarettes. The merger reshapes the U.S. tobacco landscape, creating a larger and more diversified No. 2 to Altria's lead, while granting a U.S. foothold to Imperial Tobacco.
In the end, he concludes, “Altria is hardly affected by the merger, while Reynolds American, Lorillard, and Imperial Tobacco shareholders all have reason to cheer.”