Vapor Manufacturers More Bullish Than Retailers

NEW YORK — There is still long-term opportunity in the vapor segment, but uncertainty clouds the near future. Even with some hesitancy on the part of retailers and consumers, vapor manufacturers remain upbeat, according to Well Fargo Securities LLC.

"We continue to see vast opportunity for vapor long term and continue to believe consumption of vapor and other non-combustibles could surpass consumption of combustible cigarettes in the next decade (by 2023)," said Bonnie Herzog, managing director of beverage, tobacco and convenience store research at Wells Fargo Securities. "While we estimate the industry will continue to grow robustly in 2015 (approximately 40-percent topline growth), reaching retail sales of $3.5 billion, we would be remiss if we didn't acknowledge the increased uncertainty we have observed among investors, our retailer/industry contacts and consumers over the past six to 12 months."

According to Herzog, the increased uncertainty is being driven by mixed messages from the media; a lack of Food and Drug Administration (FDA) regulation or leadership; and a lack of vapor industry or public health alignment, all of which are in turn driving worsening public perception of the vapor category. 

"This is exacerbated by the fact that it is difficult for the industry to defend itself or make any modified risk claims — that their products could be less harmful than combustible cigarettes," she said. "We remain bullish long term and continue to believe technological innovation is crucial and that Big Tobacco will be pivotal in shaping the vapor industry." 

Based on its analysis of the vapor and combustible cigarette industries over the next decade, Wells Fargo Securities continues to have conviction that: 

• Consumption of vapor products and other non-combustible products will surpass consumption of combustible cigarettes in the next decade.
• The combined margins of combustible cigarettes and vapor products will surpass combustible cigarette margins as early as 2018, driven by lower MSA payments as combustible cigarette volume is displaced to vapor.
• The growth of the combined profit pool of combustible cigarettes and vapor products will accelerate in the next decade.

"Bottom line, the industry is entering its next generation of growth and we continue to believe reduced risk/vapor products will accelerate combined profit pool growth over the next decade," Herzog explained.

In addition, Wells Fargo Securities conducted a Tobacco Talk survey of independent vapor manufacturers and key takeaways include: 

• The retail vapor market could reach $7.3 billion globally and $3.7 billion in the United States by the end of 2015.
• Total U.S. vapor segment growth is expected to be 50 percent in 2015, compared to Wells Fargo Securities' estimate of 37 percent.
• Sales mix continues to shift to vapors/tanks/mods, which are growing at three times the rate of the entire segment.
• There are 8,500 vape shops in the U.S. and 19,400 globally.
• Net pricing on vapor products is expected to be slightly down (1.3 percent) in 2015; despite this, manufacturing capacity is expected to grow 26 percent.

Regulation, though, remains a question mark. "We have become more concerned that lack of FDA regulations has caused a 'paralysis' in the industry as retailers and wholesalers are afraid to get stuck holding product they cannot sell or return," Herzog said. Therefore, they are not necessarily buying new product unless it's "forced" or required — such as VUSE/MarkTen, she added.

"Despite concerns we're hearing from our retailer contacts, our vapor industry contacts appear less concerned and 83 percent say they are accelerating their pace of innovation in 2015 with a focus on 'consumer-friendly' products," Herzog reported.