Typically, it’s not exactly welcome news when a retailer sees category sales go flat. But cigarettes are hardly your typical category.
Cigarettes are a crucial driver of c-store traffic: NACS data suggests it commands 35.9% of all in-store sales. Yet the category is widely expected to decline 3% to 4% with every passing year.
But in 2014, cigarette sales did not decline by 3% to 4%. In fact, same-store cigarette sales grew by 0.1% according to the NACS State of the Industry Report of 2014 Data, prompting Kevin Smartt, CEO of the Austin, Texas-based Kwik Chek Food Stores Inc., to proclaim at the April summit that “flat is the new up.”
As 2015 has progressed, an even more shocking trend has surfaced in the category: Up is the new up. Nielsen reported U.S. cigarette industry volumes grew by 0.5% in the first quarter of 2015, while Management Science Associates (MSA) retail shipment data suggests premium-cigarette volumes were up as much as 2% in June 2015.
Let me repeat that: Cigarette volumes were up.
“This is by far the most accommodative volumes that we have seen in Nielsen channels since the beginning of 2013,” says Vivien Azer, analyst for Cowen Group, New York. Retailers can “dare to dream” that this trend will continue well into 2015, she says.
The data is certainly promising, but what are retailers seeing in their stores? If cigarette volumes are actually improving, what’s behind this trend? And perhaps more important, is it just a fleeting fad—or maybe, just maybe, is it possible that we’re seeing a bottoming out of cigarette declines?
The majority of retailers we spoke with say the Nielsen/SOI/MSA numbers are accurate at the store level.
“We finished 2014 flat, right along with NACS data,” says Andrea Myers, president of Kocolene Marketing LLC, Seymour, Ind. “In spring, when gas prices started to decline, sales really started picking up. People have more money to spend.”
Others say a 0.5% to 2% increase is on the conservative side. Speedee Mart operations manager Ray Johnson says the Las Vegas-based retailer has seen its year-over-year cigarette sales increase by 5% as of July.
Even retailers in notoriously anti-tobacco states are noticing this phenomenon. Despite operating in a state with the second-highest excise taxes in the country, cigarette sales at Cumberland Farms are up, according to Anne Flint, senior category manager for the Framingham, Mass.-based operator.
“In the state of Massachusetts, you’d have to take a second mortgage on your house to buy a carton of Marlboros,” Flint says. “But I am seeing growth (even in carton sales), which is surprising.”
“We’re definitely seeing much better than expected volumes,” agrees RBC Capital Markets tobacco analyst Nik Modi. “I don’t think there are new consumers coming into the category. What’s probably happening is we’re seeing people buying cartons or multiple packs at a time.”
Myers says premiums are the big benefactor of this cigarette renaissance, and numbers from Nielsen back her up. The company reports premium cigarettes accounted for 80.4% of c-store cigarette sales and were up 0.4% in 2014. By contrast, branded discount sales were flat and subgeneric/private and fourth-tier cigarette sales declined.
“People are trading up,” Flint says. “They go up to premium because they can buy a Marlboro now, whereas they couldn’t before.”
CONTINUED: The Gas-Price Equation
Like Myers, Modi believes more favorable gas prices are playing a major role in cigarette sales. Sure, gas prices are no longer as low as they were in late 2014 and early 2015; but even the $2.61-per-gallon average reported by FactSet in July is significantly lower than the $3.22-per-gallon cost the United States has averaged over the past three years.
“Everyone talks about [how] gas prices coming down didn’t really help the consumer, but I think that’s taking too much of a cookie-cutter approach,” says Modi. “If you sell in the convenience channel and you sell an impulse-driven good, then you’re actually seeing the good of lower gas prices.”
It’s been a double positive for convenience operators.
“I always say, [retailers] like low gas prices, because remember: We have to pay for the gas first,” Myers says. “With lower gas prices comes better sales inside the stores because consumers aren’t spending all their money filling up their tank.”
While lower gas prices have benefited everyone, an extra $10 carries a whole lot more weight for the low-income consumers that make up the core of both convenience-store and tobacco shoppers. Modi has long tracked the “core tobacco consumer” and sees a slew of positive trends, including a 6% increase in payroll for workers without a high school diploma, vs. a 3.5% increase for workers with a bachelor’s degree or more; and construction, manufacturing and hospitality unemployment rates dipping below 7% for the first time since before the recession.
“The unweighted tobacco consumer curve we’ve been tracking for some time continues to go in the right direction,” he says. “I’m feeling very good overall about the tobacco consumer.”
“More disposable income year over year definitely plays a big role,” agrees Flint. “We’re seeing that play out in our stores.”
Yes, gas prices and the overall outlook for the core tobacco consumer are headed in the right direction. But can they really explain the turnaround of a segment that’s been declining since before the recession?
“It’s never any one thing,” says Flint. Another factor is CVS pulling tobacco from its shelves in October 2014.
“With CVS getting out of the tobacco business, we’re finally starting to see the benefits accrue toward the convenience store channel,” says Modi. “I think that is going to continue.”
Beyond the smokers who used to buy at CVS, it’s possible that c-stores are gaining customers from other drug chains.
“Even though drug stores still carry them, c-stores are one of the few places [in which] people still feel OK to buy cigarettes,” Flint says. “With CVS [exiting the category], does that give the wrong connotation for people to go into a drug store to buy cigarettes? There might be some psychological effects on purchase patterns.”
Other retailers, such as Johnson of Speedee Mart, credit a waning interest in electronic cigarettes.
“For a while, it was looking like e-cigs were going to be so much more cost-effective,” he says, also citing a lack of major e-cig product innovation. “Consumers are losing interest and maybe going back to cigarettes.”
Taxes—or the lack thereof—are also a likely source of the increase. In 2014, only Vermont raised its excise tax on cigarettes (by just 13 cents per pack), and the federal excise tax has not been raised since 2009.
Even regional issues such as weather have played a role. Though bad weather typically hurts sales, Flint says the Northeast’s record-breaking snowy winter actually improved cigarette sales for a variety of reasons.
“People figured they were never going to be able to buy another pack of cigarettes because they were snowed in, so they bought a carton or stocked up,” she says. “Some of it might also be people were home more, so they could smoke more (because of all the smoking bans).”
Whatever the reasons for surging cigarette sales, successful retailers are looking for ways to differentiate themselves in order to ride the wave.
“Our strategy has been to get more aggressive in carton sales because most of my competitors have chosen not to do that,” says Johnson, who also uses the fact that Las Vegas permits gambling in c-stores (drawing in a lot of smokers) to his advantage. Flint hasn’t focused as much on cartons or bundle deals—“I’d much rather have the customer coming into the store every single day”—but instead looks to remain competitive on price and exclusivity, thanks in part to Cumberland’s own brand, 1st Class.
“We have very competitive pricing,” she says. “We do have a very good exclusive brand that’s been growing exponentially over and above [other brands].”
Myers, on the other hand, has focused on increasing her cigarette shopper’s basket size: “We’ve done a lot of outside signage about new mid- to high-end vape items that we’ve recently started carrying.”
Though their strategies may differ, retailers are united in their message of what manufacturers can do to help boost sales: give retailers the freedom to do so.
“The cigarette folks have been laying low the past several months,” Myers says. “When they lay low, it usually means something’s coming down the pipe, so I’m bracing myself.”
“Really, what manufacturers could do is stop emphasizing the single pack price,” Johnson says. “[Reynolds’ Every Day Low Price program] and [Altria’s Marlboro Leadership Price program] are all concentrated on a cheap single price. We’ve traditionally done better when we run two-packs, three-packs or cartons.”
Flint agrees: “You have companies that want to tell you what your retail’s going to be, tell you how much you’re going to make. That doesn’t give you flexibility to run a competitive program as you might see it fit into your strategy.”
Regardless of what manufacturers or retailers do, perhaps the biggest concern surrounding the modern cigarette market is whether retailers can dare to hope that the positive sales will continue.
Cowen analyst Azer certainly thinks 2015 is shaping up to be a historically positive year, even in a worst-case scenario.
“Volumes over the last 12 months have fallen an average 4.2% (on a two-year stacked basis),” she says. “If we assume that the category reverts back to this average decline for the remainder of 2015, this would imply Nielsen volumes down 1.6%. That’s still better than the 3% to 4% volume declines we’ve seen.”
Modi points to another promising sign: Unit-sale declines have decelerated while cigarette pricing trends have remained higher than average. “I expect the pricing environment to remain favorable,” he says.
Retailers are understandably more cautious.
“It’s so hard to predict in light of the environment that we’re in,” Flint says of whether the positive trends can continue. “With the FDA, with deeming regs, with what’s next on the horizon for e-cigs—we could see a shift if the newest e-cig came out or if modified risk is approved.”
Even with all the unknowns, even with all the uncertainty, there is reason to celebrate. With positive numbers in the first two quarters, it’s very likely that the industry will have its second year in a row of flat cigarette sales.
And that, as Smartt of Kwik Chek told SOI attendees, is nothing to sneeze at: “When a $5.3 billion category in our channel goes flat after years in decline, that’s impactful.”
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