Convenience Channel Braces for a Slowdown in Cigarette Sales
NATIONAL REPORT — In early December, British American Tobacco (BAT), parent company of Reynolds American Inc., announced that it would take a hit of around $31.5 billion, writing down the value of some of its U.S. cigarette brands, and acknowledging that its traditional market had no long- term future.
This marked a first in two ways, according to Reuters. It was the first time a major global tobacco firm had written off the value of its traditional cigarette business in a major market and, at the same time, emphasized the need for the industry to focus on alternatives. RBC Capital Markets analyst James Edwardes Jones said the news exemplifies the "perils of the industry" and sends less confident signals about the outlook for cigarettes.
Similarly, Bonnie Herzog, managing director and senior consumer analyst at Goldman Sachs, called it "a very negative signal on the long-term viability of the cigarette market."
Convenience store retailers' expectations for the overall cigarettes category in 2024 are cautious. Nearly half (46%) expect their average per-store sales of cigarettes to decline this year, up 19 points from a year ago. Nearly two-thirds (62%) predict their unit volume will decrease as well, up from 59% last year, according to the findings of the recently released Convenience Store News 2024 Forecast Study.
The top factors hurting the cigarettes category, according to c-store retailers, are "never-ending" rising prices, an uncertain regulation space, and an overall decrease in cigarette smokers and associated shift toward alternative products.
[Read more: Convenience Store News Forecast Study 2024 Deep Dive: Tobacco]
"Cigarettes will continue to decline as that customer moves to smokeless, nicotine and e-cigarettes," one retailer respondent remarked. In the regulatory space, c-store retailers are particularly concerned about the proposed federal rule that would prohibit the use of menthol in all cigarettes and roll-your-own and heated tobacco products. As of press time, the proposal was with the White House Office of Management and Budget for final review. Menthol cigarettes account for 34% of total c-store cigarette sales.
Goldman Sachs' "Nicotine Nuggets" survey for the fourth quarter of 2023, representing 67,000 retail locations across the United States, found that cigarette volume declines accelerated sequentially in the quarter, and the same level of deterioration in cigarette volumes is expected this year.
"Accelerated cigarette volume declines are not a new concern, but many retailers are troubled by there being no strong alternative to cigarettes at present, outside of the modern oral category," Herzog noted.
A Bright Spot
One segment of the cigarettes category seems to be bucking the trend and that's fourth tier/deep discount brands. C-store retailers are allocating more space to this segment as they expect trade-down activity to accelerate. For some, this marks the first time they are carving out space in their stores for this segment.
Looking at the subcategories of cigarettes (super premium, premium, discount and deep discount), deep discount is the only price tier that showed any growth in 2023, according to Don Burke, senior vice president of Management Science Associates Inc. (MSA), which specializes in collecting and analyzing tobacco industry sales data.
While premium represents the majority of cigarette sales for most c-store retailers, consumers across the other three price tiers are jumping to deep discount because of the current inflation rate, gas prices and another interesting reason noted by Burke: government incentives that went to consumers who use tobacco during the pandemic ended in 2022. "Because of that, we've seen a lot of consumers today going to deep discount," he said. "It's a trend we think will continue for the next several years."
Burke also pointed out areas of the country with very distinct differences in top-selling cigarette price tiers. The middle of the country has the strongest representation in deep discount; the eastern part of the country is strongest in discount; the West Coast and New England are strong in premium; and in the South, super premium tends to sell best.
Polyusage on the Rise
Today's price-conscious consumers are not staying as brand loyal as they have been historically. They are increasingly making purchase decisions based on what is on promotion. This can even mean poly product use by smokers.
"We remain cautious on the U.S. tobacco/nicotine industry in the near term as the tobacco consumer remains under substantial financial pressure with many being more selective in their purchases and turning to more affordable alternatives, such as fourth tier/deep discount cigarettes, modern oral tobacco and, increasingly, illicit or gray market disposable vapor products," said Herzog.
Goldman Sachs' fourth quarter research found that promotional activity picked up in the quarter led by the oral nicotine and e-cigarette segments as manufacturers invest in promotions to drive conversion and volume.
Convenience store retailers are more optimistic about the other tobacco products (OTP) category than the cigarettes category this year with 56% expecting their average per-store sales of OTP to rise in 2024, a 7 point jump from a year ago, and 53% predicting their unit volume will increase, a 20 point jump from last year. Nearly half of retailer participants in this year's Forecast Study (48%) said they plan to add more OTP SKUs this year, and 41% plan to devote more square footage to OTP.
The high cost of premium cigarettes, as well as the growing variety of product options available in OTP, are expected to positively impact this category in 2024.
Flavor Ban Effect
Shifts in category and consumer spending dynamics have been further exacerbated by flavor ban momentum at the state and federal levels, and uncertainty regarding the future of the e-cigarette category and category innovation as the U.S. Food and Drug Administration is still reviewing premarket tobacco product applications for big market brands, Goldman Sachs noted in its latest "Nicotine Nuggets" survey.
[Read more: Massachusetts Faces Fallout From Flavored Tobacco Ban]
MSA's Burke points to California's flavor ban (menthol cigarettes included) that went into effect in December 2022 as a case study for retailers to consider. The firm's research showed that while cigarettes were down more than twice as much in California as the rest of the U.S. (-14% and -6%, respectively) in the second quarter of 2023, they were down half as much as the rest of the U.S. (-3%) in California's surrounding states of Oregon, Nevada and Arizona.
"Many of those California consumers traveled to outside the state to get the type of products they want," Burke explained.
Focusing only on menthol cigarettes for the same period, California was down almost 100% while the rest of the country was down 6.3%. The same surrounding California states were up 10.1% in menthol for the period.
So, the lesson to retailers in states and localities that surround states and localities that put flavor bans in effect is that they should pay attention to and increase their menthol cigarette supply and expect an uptick in sales, according to Burke.
Not all the news was bad for California, however, as it did show an increase in nonmenthol cigarette sales (up 5.3%) during the same period, showing that many consumers who don't want to travel outside the state will switch to nonmenthol.
For retailers in states and localities that do go through flavor bans, there is opportunity for them to increase their nonmenthol supply of cigarettes, Burke advised.