Tobacco Heating Up in Nontraditional Areas

New growth engine gaining legitimacy, but will it help category development?

Samantha Oller, Senior Editor/Fuels, CSP

Nik Modi

NEW YORK -- As the economy warms up, the tobacco category is heating up as well--in some nontraditional areas. At a recent CSP Tobacco Update webinar, presenters provided a status report on the latest developments in cigarettes and other tobacco products (OTP), against the backdrop of an improving--if choppy--economic picture.

"The trend continues to remain favorable--unemployment rates for construction, manufacturing and service employees have come down significantly over the past couple years and is definitely outpacing improvement seen in the broader economy," said Nik Modi, a tobacco analyst for UBS, New York. He also pointed to the recovery of the housing market, which is helping low- and middle-income consumers.

And despite a cold and wet spring for much of the country, which has dampened retail sales overall, "I believe things are getting better on an underlying basis, and that's linked primarily to the housing market," said Modi.

On the cigarette front, Altria's Marlboro continues to gain share, Reynolds American is holding ground with Camel, Pall Mall and Santa Fe, while Lorillard's Newport is re-widening its performance gap vs. the industry, according to Modi.

Most of the analyst's comments, however, focused on a cigarette alternative that is seeing explosive growth.

Modi expects total electronic cigarette sales to double in 2013 from approximately $500 million to $1 billion, an estimate he considers conservative. He also expects more of these sales to migrate from online to retail, with the current split at 60/40 (retail vs. online).

"I certainly think that percentage will grow for retail, especially as leading online players start to migrate to bricks and mortar distribution," he said. Recognizing that the top 10 e-cigarette brands have a very low distribution, the incremental revenue generated from the segment will soon outpace that of smokeless tobacco.

"It's wild to think about," Modi said. "Smokeless tobacco has been a nice growth engine for the industry over the last five years. To see e-cigarettes trump it by three to four times already is quite astonishing."

Driving this growth is the entry of the major cigarette manufacturers into the e-cigarette business: Lorillard with Blu, Reynolds with its new Vuse, and Altria's new MarkTen. "Blu e-cigarettes contributed to more than half of Lorillard's revenue growth in the last two quarters," he said. "I just think that's an astonishing number considering the infancy of this category. This category has the ability to singlehandedly transform income statements and the industry, quite honestly." While he does not expect it to eclipse cigarettes 10 years from now, it could become a truly significant part of the industry.

Of course, one big unknown--regulation by the Food & Drug Administration--will shape the size of this opportunity. "The FDA could singlehandedly make or break this category," Modi said, although he said that the appointment of a former surgeon general to NJOY's board of directors creates legitimacy for e-cigarettes, especially considering the debate among tobacco control and public health officials.

"Two things regulators are really focused on, aside from product quality … is youth consumption—no one wants this to be a gateway product—and incremental nicotine consumption." Will e-cigarettes prove to be used as a replacement for cigarettes, or simply a way to supplement with more nicotine.

"Make no mistake about it--many public health officials think e-cigarettes could become the go-to tool for tobacco control," said Modi. "Regulatory support of this category will be the single biggest driver for next 10 to 20 years." If regulation supports e-cigarettes, taxation does not reach the same level as traditional tobacco products and the FDA empowers relative risk communication, it will prove a huge win for the category.

For c-store retailers, the explosive growth of e-cigs means greater competition for that business. "The battle is going to escalate in that sense that … now you have to worry about other channels of distribution potentially becoming competitors," said Modi, citing "vape shops," which specialize in e-cigarettes, as well as online sales.

"The traditional blocking and tackling we see in cigarettes, smokeless, cigars and all of those other categories--I think needs to come to the forefront if you want to win in this category over time," he said. "It's important to think of this not as an emerging growth category ... but really how do you become a part of the category development? Those who become part of the category development will capture most of the economics."