Retailers accustomed to flat-to-positive cigarette volumes need to prepare for the “normalcy” of the category’s decline returns, analysts say.
At the same time, multiple indicators—from a Republican administration to relatively low gas prices—bode well for the category.
That mixed bag of challenges and opportunities presents retailers with greater odds for success, at least in the near term, said Nik Modi, managing director of RBC Capital Markets, New York. Speaking during a CSP-Swedish Match webinar in February, Modi said a stable consumer base is the foundation for his predictions.
Near-term economics “are favorable for the blue-collar worker,” Modi said. Small businesses’ intent to hire, housing starts and consumer confidence are all up.
Separately, Stefanie Miller, investment analyst for Height Securities, Washington, D.C., pointed to another positive factor in the equation: the “Trump effect.” Tobacco issues are far down Take deeming: If Republicans were able to change the current deeming rule to favor new products and the vaping industry, “it’s something Trump would not veto.”
So despite cigarette volumes projected at a 2% to 4% decline for 2017—compared to 0.4% growth a little more than a year ago—retailers can come out on top if they make the best of several trends:
A continuing move to premium. Modi predicted the momentum toward premium products will continue. The Santa Fe Natural American Spirit (NAS) brand from Winston-Salem, N.C.-based Reynolds American is on an upward trend, and with Richmond, Va.-based Altria Group buying premium-cigar and cigarette maker Nat Sherman, New York, earlier this year, the energy behind these higher-end offers will only build.
E-cigarette disappointment. Retailers will continue to struggle with electronic cigarettes, Modi said. While 100% of retailers surveyed carried e-cigarettes in 2014, only 85% reported carrying them today, according to an RBC and CSP retailer survey.
Looming U.S. Food and Drug Administration regulations have cramped innovation, and retailers have had a hard time finding products that continue to resonate with consumers.
That said, Modi is holding out hope for New York-based Philip Morris International and its “heat-not-burn” product iQOS, which is expected to hit the U.S. market in 2018.
The BAT-Reynolds merger. While Modi expects the merger of London-based British American Tobacco (BAT) and Reynolds to mean little change for retailers, he predicted that Reynold’s Pall Mall brand will receive more resources nationally vs. the Camel brand, because a competitor owns the global rights to Camel.
Miller of Height Securities also sees little retail disruption. With the market controlled by a limited number of players, consumer loyalty for the strongest brands will be hard to break. As a result, she would expect the status quo even after mergers of global breadth.
“[Even down to the] retail level, the distribution relationships are engrained and have been solidly in place for years, so you wouldn’t have an advantage in [buying] … a group of brands and trying to disrupt the market,” Miller said.
For the top two U.S. manufacturers, Altria and Reynolds, expect volume declines for 2017 in the range of 2% to 4%, Modi said, with subtle differences between their big brands. For Reynolds, he projected growth in its Newport brand of about 1.5% in 2017, with a long-term decline rate of 0.5% year over year. For the Camel brand, promotional and brand-expansion efforts will keep volume declines at a low 1%, Modi said.
Altria’s Marlboro brand will decline by 3% in 2017 and 3.5% long term, Modi predicts.
Prices will increase 4%, which he said is in line with Altria’s historic trends. Retailers should also watch out for the majors’ “tail-brand strategy,” Modi said. That key tactic of focusing on high-volume brands will keep prices along the supply chain stable.
Why? In a recent RBC Capital report, Beverages, HPC and Tobacco—The Playbook for 2017, Modi said all the tobacco companies define success with their “focus brands.” These include Marlboro for Altria; Newport, Camel, Santa Fe NAS and Pall Mall for Reynolds; and Winston, Kool and, to a lesser extent, Salem, USA Gold and Maverick for the No. 3 tobacco manufacturer, Greensboro, N.C.-based ITG Brands.
Over the next three to five years, Modi expects these manufacturers to hold or gain share in their core portfolio or focus brands, at the expense of their noncore portfolio.
The focus brands for the big three now have 79% share of the market, while the nonfocus portfolio represents 17 share points. (See chart below.)
The manufacturers’ strategies could ultimately bring additional stability to the category, with more time and energy given to fast-moving brands. For retailers, the hope is that a new normal will also be profitable.
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