Cigarette Price Increases Likely Soon

Wells Fargo retailer, wholesaler survey predicts modest hike in May or June

NEW YORK -- More than 70% of the contacts in a Wells Fargo Securities LLC survey of tobacco industry retailer and wholesale trade contacts representing more than 10,000 U.S. convenience stores expect a cigarette price increase in May or June.

Bonnie Herzog, managing director of beverage, tobacco and consumer research for Wells Fargo said that she anticipates a five-cent-to-seven-sent-per-pack increase on most brands led by Altria Group Inc.'s Phillip Morris USA.

"We continue to believe this industry has pricing power, which is critical to driving top-line growth," said Herzog. "Furthermore, we feel a price increase will help to offset some pressure on margins stemming from the 'Battle of the Brands' in the second tier."

The survey revealed:

  • Marlboro volume appears to be stabilizing, driven by stepped-up promotions and innovation. More than 45% of the survey respondents indicated a low-to-mid-single-digit volume increase in Marlboro during the first quarter, with a similar percentage noting increased promotional support on Marlboro. Total Marlboro volume growth is likely being driven by Marlboro Special Blends and the successful Marlboro Black launch in December 2011. "Despite higher promotional spending, we are encouraged by Marlboro volume trends suggesting share stabilization. Bottom line: we continue to see signs that PM USA is achieving a better balance between leveraging Marlboro for profitable growth and maintaining strong brand equity. Therefore, we believe PM USA will be successful in preserving margins with a combination of share gains, cost-savings initiatives and new, innovative products," Herzog said.
  • Pall Mall fights to defend its turf with increased promotions, but volume growth appears to be slowing. "Given heightened promotional activity among the second-tier brands, Pall Mall continues to be under siege. Given that Pall Mall is [Reynolds American Inc.'s] largest cigarette brand, we believe it has the most to lose as this 'Battle of the Brands' among the second-tier continues to heat up," she said. A total of 35% of the contacts indicated Pall Mall volume decreased mid-to-high single digits during the first quarter. "Therefore, to defend its turf, RJR would need to continue to increase its promos on Pall Mall, which could put pressure on its margins in the near term," said Herzog.
  • Newport Menthol continues its strong growth trajectory. Most of the retail trade contacts indicate mid-to-low double digit volume growth in the first quarter, with the vast majority indicating flat promotions. "We increasingly believe Newport Red will need to be promoted more than originally anticipated to grow," she said.
  • Smokeless volume trends continue on an upward trajectory, aided by increased promotions. More than 80% of the contacts indicated mid-to-low-double-digit volume growth. Several contacts mentioned the growth being driven by Grizzly. "Pricing is healthy, in our view, as 45% of respondents suggested flat promos," said Herzog.
  • Altria's strategy with Copenhagen and Skoal is similar to Marlboro Special Blends--leveraging premium brand names into value-priced line extensions to drive volume. Growth in Altria's smokeless category seems to be driven by the mid-tier Copenhagen and Skoal line extensions. "While we do share our trade contacts' concerns about dilution of brand equity from these lower-priced line extensions, we believe [Altria's] is leveraging these brands to stabilize share, offering a price point that is compelling to the consumer. Volume growth and cost-savings initiatives should more than offset margin pressure as [Altria] executes its total tobacco strategy," Hezog said.