Taking the Pulse of Tobacco
LAS VEGAS — Change is the only sure thing in the tobacco category, but how fast it comes depends on which angle you are looking from: market trends or legislative trends.
Market conditions and the legislative scene were key topics addressed by the National Association of Tobacco Outlets (NATO) in its Industry Outlook, co-located for the first time this year at Tobacco Plus Expo (TPE) 2018, which took place this week in Las Vegas.
Generally speaking, retailers think the U.S. economy is solid. This comes as U.S. retail sales accelerated through year-end 2017. Notably, small business optimism is at a peak, according to Nik Modi, analyst with RBC Capital Markets, which he said is notable because small businesses drive the economy.
Retailer optimism may be poised to climb even higher as tax reform takes hold, Modi noted during the Industry Outlook. This reform will also have an effect on traditional tobacco consumers, who tend to be lower income. The extra money these consumers receive will be spent in the marketplace, he explained.
That being said, the state of the tobacco industry does depend on several key factors:
- Gas prices: Though they spiked in January, gas prices have remained relatively stable.
- Excise taxes: The $2 increase in California put pressure on the industry in 2017. States to watch this year include Connecticut, Delaware, Indiana, Kansas, New York and Ohio.
- Industry pricing: Based on historical trends, the next price increase is expected in March and will come in at the 9-cent to 10-cent range.
Regulatory dynamics also weigh on the tobacco industry. In summer 2017, the Food and Drug Administration (FDA) shifted its regulatory approach to tobacco to now focus on nicotine. However, it's too early to assess the effect of this change, according to Modi.
"The menthol issue hasn't been resolved at the federal level yet and that started seven years ago," he pointed out. "These things take time."
Before lowering nicotine levels, the FDA will have to look at possible unintended consequences and a potential increase in contraband products.
Other issues topping regulatory agendas across the United States are age restrictions and flavor bans.
Change in the tobacco industry is likewise being seen in the leading brands. In the cigarette segment, Camel was a leading brand from 1913 to 1960, followed by Winston from 1966 to 1975, which ceded the title to Marlboro in 1975. Marlboro remains the leader today, though it has been losing market share, said Modi.
"I don't think Marlboro will go the way of Camel in the '70s, but things are changing quickly. The brands that are leading today may not be the leading brands in five years," he added.
In regards to electronic cigarettes, Modi admitted to being negative toward the category initially because the science and technology were not good enough. The category is getting better, he acknowledged.
And while it takes time for mass adoption, "consumers today are much more willing to adopt new technology and that's a good thing for this industry," he said.
When it comes to selling tobacco products, convenience stores and gas stations still lead all traditional classes of trade. With approximately 56 percent of all stores in the U.S., the convenience channel accounts for about 70 percent of nicotine volume, shared Don Burke of Management Science Associates.
Tobacco outlets make up 3 percent of all U.S. stores and 8 percent of the nicotine volume.
"Clearly, tobacco outlets and the convenience channel are very important to the category," he said.
In his opinion, though, the channel to watch is the dollar channel. Currently, dollar stores account for 2 percent of the nicotine volume, but they have the potential to take more share, Burke cautioned.
According to data on total U.S. nicotine trends, dollar store volume increased 12.5 percent in the third quarter of 2017 vs. a year ago. Distribution grew 24.5 percent. Conversely, c-store and gas station volume dipped slightly by 0.5 percent, and distribution grew slightly by 0.7 percent.
Looking at the individual segments within the tobacco category, the third-quarter numbers showed cigarettes' share of the category volume down from 71.4 percent in the third quarter of 2016 to 69.1 percent in the third quarter of 2017. However, it is still the category leader by far. The No. 2 segment, large cigars, came in at 18.2-percent share for the third quarter of 2017 vs. 16.1-percent share in the prior-year quarter.
Dollar stores are paying a lot of attention to cigars. Specifically, large cigar volume grew 24.1 percent in the dollar channel between the third quarter of 2016 and the third quarter of 2017.
Moving to the legislative side of the tobacco business, the industry has been grappling with the FDA's deeming rule and policy shift, but the real obstacle lies much closer to home — local tobacco ordinances.
"Local tobacco ordinances are the most significant threat to retailers," said Brian Carr, NATO's deputy executive director.
Overall, there were 400 local tobacco issues topping agendas in 2017, according to Carr, and each one grew more restrictive. Three states especially stand out for tobacco legislation: California, Massachusetts and Minnesota.
The measures generally fall into four categories:
- Flavor bans;
- Minimum cigar package size and prices;
- Limit on number of tobacco retailer licenses; and
- Higher legal minimum age to buy tobacco products.
"The goal of anti-tobacco advocates is not to restrict tobacco products, but to prohibit the sale of a legal product," Carr said.
In the past five years, the tobacco fight has shifted from the state level to the local level — mainly because there has been minimal movement at the state level.
And, he warned, even if these issues have not reached your community, they are coming.
"The time to engage is before the restrictions are at your door," he said. "Then, it is too late."
Change at the federal level, on the other hand, is going to take some time. The FDA announced its regulatory shift to reduce the nicotine level in cigarettes in July, and the agency is accepting public comments on the topic. Based on past regulatory experience, it may take years to implement, said Thomas Briant, executive director of NATO.
"The timeframe is status quo," he remarked.
Tobacco Plus Expo 2018, held at the Las Vegas Convention Center, ran Jan. 31 through Feb. 1. The NATO Industry Outlook was held Jan. 30.