C-store Tobacco Market Softening Slightly, But Still Solid

NEW YORK — After experiencing a strong 2015, the cigarette industry is seeing volumes decelerate closer to historical ranges.

Many industry players have been forecasting the return to normal and those tobacco manufacturers with the strongest brand equities and marketing depth are in the best position. 

According to Wells Fargo Securities LLC's latest Tobacco Talk survey, the overall tobacco environment remains in solid shape but is seeing a slight softening given the decelerating cigarette volumes — which were down 1.7 percent in the third quarter vs. historical declines of 3 to 4 percent.

Tobacco Talk surveys retailer and wholesalers representing roughly 25,000 convenience stores in the United States.

Tobacco consumer demand is also softening, driven by the flattening of disposable income and less purchases power as gas prices, taxes and healthcare costs rise, said Bonnie Herzog, managing director of tobacco, beverage and convenience store research at Wells Fargo Securities.

In addition, she explained, the industry saw solid cigarettes manufacturer net price realization of around 5 to 6 percent in the third quarter. A price increase of 7 cents a pack is expected in mid-November, Herzog added.

According to Herzog, the key brand winners are Newport, which is now part of Reynolds American Inc.'s (RAI) everyday-low price platform (EDLP), with Altria Group Inc.'s Marlboro a close second. RAI's Natural American Spirit is winning in the super-premium segment and Grizzly stands out in smokeless tobacco.

However, ITG Brands LLC and Skoal are among the losers, she added.

"We remain positive on the U.S. tobacco sector and believe the risk/reward is broadly favorable for Altria and RAI based on their strong relative positioning and positive feedback from our retailer contacts," Herzog said.

Taking a closer look at brands, retailers in the Tobacco Talk survey said they expect Newport to gain 100 basis points of incremental share this year, which is slightly lower than previous polls but still more than triple the share Newport gained in fiscal year 2015.

"We believe this reflects Newport's faster growth from greater shelf space as part of RAI's EDLP program." Herzog explained. "However, offsetting Newport growth are reported declines in Camel and Pall Mall as 'Tier 4' price brands gain traction."

Bottom line, though, Wells Fargo Securities believes, "RAI remains strongly positioned for share gains, leveraging Newport to drive faster growth across its entire portfolio and meaningful margin expansion," she added.

Marlboro is holding its own against tough competition and is benefiting from stepped-up promotions as its works to hold off Newport, Herzog said, adding the brand's MHQ mobile is helping Marlboro.

"We remain encouraged by retailers' continued positive feedback on Altria's Marlboro app, which suggests Altria's customer engagement is improving," she explained. 

Nearly 70 percent of retailers report using the app in stores vs the same in July and 63 percent in April, she added. Retailers also said the app is starting to have a positive impact on volume.

"We continue to believe Altria is ahead of its peers in its use of technology and leveraging digital to modernize engagement with consumers," Herzog said.

Calling it the "most interesting development," Herzog said retailers are excited about the opportunity with reduced-risk products (RRPs). She noted heat-not-burn "intrigues" retailers, with all eyes on Philip Morris International's (PMI) iQOS.

"Nearly 60 percent of retailers are optimistic about the future of RRPs, roughly in line with our July survey," she said. "But interest in heat-not-burn technologies and iQOS specifically has increased, laying the groundwork we think for an eventual industry pivot toward RRPs as the next growth catalyst on the horizon."

That would be a positive for Altria, which announced a strategic framework with PMI to commercialize reduced-risk products and electronic cigarettes in December 2013. The pact was expanded summer 2015 to include a joint research, development and technology-sharing agreement, as CSNews Online previously reported.

"While further out, we see this as strongly positive for Altria given its alliance with PMI on iQOS since we continue to expect the commercialization of iQOS as early as late fiscal year 2017/early fiscal year 2018," Herzog said. "More immediately, this bodes well for RAI as retailers are also optimistic about the new VUSE Vibe platform."