LAS VEGAS -- Price increase. It's a word few retailers want to hear when it comes to cigarettes, especially with Obama proposing a 94-cents-per-pack increase to the Federal Excise Tax (FET) in his most recent budget.
Bonnie Herzog sees modest price increases differently. "Pricing power has been critical and key to this industry," she said during her Tobacco Trends & Insights session at the 2013 NATO Show in Las Vegas earlier this week. "In terms of the bottom line, one point of pricing offers three times the leverage compared to one point of volume."
Yes, cigarette sales are declining, but Herzog--managing director of tobacco and consumer research for the New York City-based Wells Fargo Securities LLC--noted that more than 20% of the population still smokes and, most likely, modest increases will not deter the majority of them.
"Mid-single-digit price increases more than offset cigarette volume declines, driving top-line growth and higher margins for some," said Herzog.
Herzog anticipates that these kinds of price increases will continue to occur in 2013 based on recent earnings calls by major tobacco companies. At the time of the session, Lorillard and Reynolds had released their first-quarter 2013 earnings, with Altria soon to follow.
"I've predicted that pricing will accelerate by four points this year," she said. "It's still early, so I reserve the right to adjust that estimate--but I think it will accelerate by at least four points, if not more."
While cigarette pricing will almost certainly accelerate in 2013 and 2014, 2015 presents an interesting opportunity for tobacco manufacturers, shareholders and retailers alike: fourth-quarter 2014 marks the end of the Federal Tobacco Buyout Fee (also known as the Tobacco Transition Payment Program).
"This 10-year, $10.1 billion program costs approximately 0.06 cents per pack," Herzog said. "This should result in significant upside potential to operating margins and earnings growth in 2015 for all three of the leading tobacco manufacturers in the U.S."
"Therefore, in just a few years, we anticipate that tobacco operating margins will be re-based upwards by approximately 250 to 300 basis points," she continued.
It may be too early to predict exactly how manufacturers could use these cost savings, but Herzog said they would not use it to lower cigarette prices that consumers have already become accustomed to.
Some possibilities on how the funds could be used include funding internal growth initiatives, offsetting potential federal and state excise tax increases, funding higher promos to drive volume, stepping up share buyback programs, acquiring or investing in a growth business and/or increasing dividend payouts.
"It's a long way off so it's too early to know for sure how these savings will be used," Herzog said in summation. "It's just something to keep in the back of your mind."
Members help make our journalism possible. Become a CSP member today and unlock exclusive benefits, including unlimited access to all of our content. Sign up here.