New Tobacco Study Raises Cigarette Price Hike Possibility

NEW YORK -- This time of year typically sees an uptick in gas prices, but this year, cigarettes prices may be the ones doing the climbing.

The Wells Fargo Securities 1Q12 U.S. Tobacco Retailer Survey found that more than 70 percent of the company's tobacco industry retailer and wholesale trade contacts expect to see a price increase in May or June. Wells Fargo Securities anticipates The Altria Group's Philip Morris USA division to lead the 5-cent to 7-cent bump, according to Bonnie Herzog, managing director of Beverage, Tobacco & Consumer Research.

Even with the expected increase, she added that the company continues to believe the industry has pricing power. "Furthermore, we feel the price increase will help offset some pressure on margins stemming from the 'Battle of the Brands' in the second tier," she explained.

Breaking the survey down to individual brands, Wells Fargo Securities found that Marlboro volume seems to be stabilizing driven by increased promotions and innovation. Specifically, more than 45 percent of those responding to the survey reported a low-to-mid-single digit volume increase in Marlboro during the first quarter. A similar number of respondents noted an uptick in promotional support for the brand as well.

Herzog added that Marlboro Special Blends and the December 2011 launch of Marlboro Black are likely driving the volume activity.

"We continue to see signs that PM USA is achieving a better balance between leveraging Marlboro for profitable growth and maintaining strong brand equity," she said. "Therefore, we believe PM USA will be successful in preserving margins with a combination of share gains, cost-savings initiatives and new, innovative products."

Marlboro is not alone in its increased promotional activity. Pall Mall is also stepping up promos, but volume growth appears to be slowing down, according to Wells Fargo Securities. And with increased promotional activity among all second tier brands, it continues to be under attack.

"Given that Pall Mall is [Reynolds American Inc.'s] largest cigarette brand, we believe it has the most to lose as this 'Battle of the Brands' among the second tier continues to heat up. Thirty-five percent of our contacts indicated Pall Mall volume decreased mid-to-high single digits during [the first quarter]," Herzog explained. "Therefore, to defend its turf, RJR would need to continue to increase its promos on Pall Mall which could put pressure on its margins in the near term."

The tobacco survey also found that Newport Menthol continues its strong growth trajectory with the majority of the respondents indicating mid-to-low double digit volume growth in the first quarter. The vast majority also indicated flat promos. However, Herzog noted that Lorillard Inc. will need to promote Newport Red more than originally anticipated in order to grow that brand.

The survey also pointed to smokeless tobacco products as bright spot in the tobacco category. With the help of increased promotions, smokeless volume trends continue to rise with more than 80 percent of respondents reporting mid-to-low double digit volume growth. Furthermore, Herzog noted that several of Wells Fargo Securities contact pointed to Grizzly as a factor in that growth.

Altria is also seeing growth in its smokeless category, primarily driven by the mid-tier Copenhagen and Skoal line extensions, she added, which had some retail contacts raising their eyebrows. "While we do share our trade contacts' concerns about dilution of brand equity from these lower-priced line extensions, we believe [Altria] is leveraging these brands to stabilize share, offering a price point that is compelling to the consumer. Volume growth and cost savings initiatives should more than offset margin pressure as [Altria] executes its total tobacco strategy," Herzog explained.