Tobacco Challenges Piling Up

Profits squeezed as volume slows, according to retailer survey

NEW YORK -- The competitive environment is adding one more reason for convenience store retailers to worry about tobacco sales trends, according to a recent survey of c-store retailers and wholesalers.

“Our survey respondents indicated the competitive environment was slightly more intense vs. last quarter,” wrote Bonnie Herzog, senior analyst for Wells Fargo Securities in a Tobacco Talk report titled “Q1 2013 U.S. Tobacco Retailer Survey.

Among the concerns weighing in retailers’ minds:

  • Dollar and drug stores have gotten more meaningfully involved in the tobacco category.
  • Cool weather, high gas prices and higher payroll taxes impacted the low-to-middle income consumer.
  • The relative price gap widened slightly, resulting in increased downtrading pressure.
  • Deep discount brand activity has picked up slightly given strained consumer.
  • E-cigarettes appear to be taking share of the total tobacco category.

Herzog surveyed tobacco retailer and wholesaler contacts representing more than 45,000 convenience stores in the United States.

“According to our survey, volume growth for the industry and all major brands decelerated in Q1,” Herzog wrote. “We anticipate industry reported volume was down close to -4.5% during Q1, which is a deceleration and toward the low end of the long-term industry decline rate of -3%-4%.”

She noted, however, that promotional support decreased for most brands, suggesting accelerated net price realization for cigarettes in Q1. “This could drive increased profitability as cigarette manufacturers realize three times the leverage on a point of pricing vs. a point of volume. We believe the industry is on track for net price realization to accelerate in fiscal year 2013 to +4%, up from +2.9% in 2012.”

Herzog said the “outlook is increasingly rosy for e-cigarettes as nearly 90% of our respondents indicated the category accelerated in Q1 vs. Q4, with annual growth topping 30%.”

Retailers have become incrementally more positive on the category, she said, and have praised the advertising and marketing efforts of e-cig manufacturers.

Cigarette sales account for about 45%-50% of merchandise sales for the average c-store, but profits on cigarettes have been squeezed by the manufacturers with gross margins of only about 20% vs. 30% gross margins on most other merchandise and 50% gross margins on food service, Herzog said.

“Given the disproportionate impact tobacco has on c-stores' merchandise gross profit, decelerating volumes in this important category could pressure c-stores' merchandise same-store sales this quarter.”

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