Special Report: Tobacco on Fire

Finding rays of light behind the SCHIP/FET tax

Mitch Morrison, Vice President of Retailer Relations

Editor's Note: This is the first of a four-part CSP Daily News series on how retailers are reacting to the federal excise tax on tobacco that begins in April.
HENDERSON, Nev. -- Shortly before the new federal excise tax (FET) on tobacco kicks in, Ray Johnson is scanning up and down his shelves of cigarettes, snuff and cigars.

A profit machine for this Henderson, Nev., operator, tobacco is about to take a hit. On April 1, the largest FET hike on all tobacco takes hold. The levy is expected to cover a nearly $33 billion, 4-year reauthorization and expansion of [image-nocss] the State Children's Health Insurance Program (SCHIP).

For all retailers, the tax, which cuts into every established segment of tobacco including steep levies on roll-your-own and little cigars as well as a 62-cent increase on a pack of cigarettes, is bad news. For someone lacking a serious foodservice program or alternative in-store driver, it's even worse.

"When I look at our cigarette sales, you can't just look at total sales, you have to look at cartons. Carton [sales are] going to drop 5%-7%," Johnson, operations manager at Speedy Mart, a 21-store chain based in Las Vegas valley, told CSP Daily News. "What's going to happen, I assume, is that people are going to buy down to the lower brands as they adjust to the impact."

For Johnson, the tax threatens a category that pumps about 40% of his inside sales and more than 40% of store profit. If Johnson stands pat, Speedy Mart sales could collapse. So he is making a pre-emptive strike. Since there's little he can do about the tax, Johnson is attacking his plan-o-gram, altering the face of his tobacco set. He is also shrinking inventory to reduce the burdens of a one-time floor-stock tax that is expected to cost retailers between $2,000 and $3,000 per store.

"We'd already started with a SKU reduction program," he said. "The idea is to get rid of the slow sellers; we're going to mark them down and sell them now so we don't have to pay the floor tax on them. I've eliminated nearly 100 SKUs between cigarettes and cigars. I'd rather sell them below tax than pay the tax."

While the FET increase has captured great attention, it is the floor-stock tax, which requires collection and payment by Aug. 1, that has Johnson particularly irked.

"We're trying to put away funds for the amount that we know is coming. I don't know how they think you suddenly have this magic wand to pay for all this. We don't have the cash sitting there just to say, 'Oh, you can pay this on all your existing stock.' I understand the theory, 'When you're going to sell it, you're going to collect it.'

"[But] when I sell it, I only collect a little bit, and I'm still only making my 20% margin, I'm not making this huge profit. We are concerned on the cash flow. The biggest thing really was reducing the inventory, reducing SKUs, getting the dead merchandise out so we don't have to pay the tax on them."

What does Johnson expect his new set to look like?

First, expect all packs of cigarettes to go up 75 cents, much in line with what analysts predict. Also, while Marlboro will remain his featured brand, Johnson expects customers to sample with lower-tier products to save a dollar or two.

"Nearly 70% of my sales are Marlboro, so I am on the max level with them," he said. "And we take surveys every week on Marlboro prices, so that's where the competitiveness is. Beyond that is whatever is the cheapest brand. And that's another 10% more." The remaining brands make up 20%.

Johnson's cigarette breakdown could become more interesting in the ensuing months.

"When I look at our cigarette sales, you can't just look at total sales; you have to look at carton [sales]. What's going to happen, I assume, is that people are going to buy down to the lower brands as they adjust to the impact. A lot of cigarettes here are sold to California. Every weekend I-15 between here and California is packed; our state tax is cheaper.

"We suspect [carton traffic] will be the same, but instead of buying Marlboro, they'll be buying our lower ends. The high-end guys, I expect theirs to really start falling off. But carton movement, I don't think it'll drop more than 5%. I think our net-gain sales will be up a little, and margin is going to be down a little."

For other tobacco products, Johnson believes little cigars will be whacked.

"[The tax increase is] going to really impact the little cigars the most because right now they're going to be taxed the same as cigarettes," he said. "The original version, it was going to go up 25 cents every two years." The final version jumps little cigars from 4 cents a pack to more than $1.

Such news should perhaps cause anxiety. But Johnson is taking it in stride.

"I'm going to just let cigarettes fall where they may. It doesn't scare me, because it's going to happen to everyone," he said. "We're going to spend the last month doing nothing but educating consumers on what's to come."

For more about SCHIP and its impact on c-stores, see the April issue of CSP Magazine.

Mitch Morrison Winsight CSP By Mitch Morrison, Vice President of Retailer Relations
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