Retailer Survey Indicates Tobacco Pricing Remains Healthy

NEW YORK -- In December, the big three tobacco companies hiked their cigarette prices, with The Altria Group's Philip Morris USA leading the initiation with a nickel increase. Now more than six weeks into the increase, industry trade contacts are reporting that the hikes appear to be sticking and overall the pricing environment is healthy, according to Bonnie Herzog, managing director, Beverage, Tobacco & Consumer Research, at Wells Fargo Securities.

"We continue to remain encouraged by the industry's pricing power and we think the tobacco companies have been successful in engaging in price increases to offset declining volumes," Herzog wrote in an e-mail. "Further, we believe the manufacturers have become increasingly efficient and effective with varying promotional support."

As prices change, there is continued pressure on consumers to switch from premium to discount brands, according to the Wells Fargo U.S. Tobacco Retailer Survey. However, the relative price gap between the two remains narrow, restraining the downtrading pressure. Though, some pressure does still exist.

"Indeed, the majority of our contacts felt that non-premium brands such as Marlboro Special Blends, L&M and Pall Mall increased [year over year] in 4Q11. We are expecting double-digit [year over year] volume increases in brands such as Pall Mall and Maverick as these brands continue to buck the overall cigarette industry trend in appealing to a challenged consumer," Herzog explained. "Bottom line, the second tier 'battleground' is more crowded with heightened focus behind Pall Mall, Marlboro Special Blend, L&M, Newport Red and Maverick."

Pointing to Marlboro brands, Herzog wrote that experts expected Marlboro Special Blends to see an uptick in volume during the last quarter of 2011 driven by promotion activity. However, she cautioned that PM USA should slowly ease up on the promotional support behind the special blend product line to avoid dilution. This may be hard to do, she noted, since consumers have been conditioned to lower price points, citing one retailer who said "without discounting, the Blends will drop like a stone."

PM USA also continues to deal with retailer frustration over its Marlboro Leadership Price (MLP) program, Herzog said.

"In general, retailers have been less than pleased with PM USA's MLP program given that it puts pressure on retailers' gross margins," she commented. "However, feedback was mixed with regards to whether or not MLP will ultimately help to boost Marlboro's share. Half of the retailers suggested Marlboro volume declined during Q4. PM USA continues to modify its MLP program, which is a sign in our view that the company is willing to work with retailers, as well as continue to find a way to achieve the company's goal of growing Marlboro share profitably. It also highlights the movement of intense price competition to the lower rungs of the pricing ladder."

One a brighter note, Herzog said PM USA's L&M brand is poised to go head-to-head with Pall Mall, according to feedback from industry trade contacts. Retailer feedback was mixed, but Herzog remains positive on L&M. "We ultimately think it could prove successful if L&M can replace Marlboro Special Blend in its positioning against Pall Mall," she concluded.