Smoke and Mirrors?

Can ongoing price increases on cigarettes continue to compensate for dropping unit sales?

By Anne Baye Ericksen, Contributing Editor

In early November 2016, Philip Morris USA, owned by Altria Group Inc., Reynolds American Inc., and several other tobacco companies added eight cents to the per-pack wholesale price of their top cigarette brands. ITG Brands upped the ante by levying a 16 cent hike.

The move isn’t a surprise to convenience store owners, operators and managers as it reflects a trend of price increases that’s been happening since 2014 for most manufacturers. What’s more, it appears the pattern will continue into 2017.

According to Nielsen data reported by Wells Fargo Securities, pricing of cigarettes in all retail channels jumped 3.5% for the four weeks ending Dec. 3. The price boosts, however, have not translated into proportionate sales gains. For the same four weeks, sales dollars grew by 1%. In a 52-week comparison, dollar sales for cigarettes rose 1.6%.

Rather, the price increases have buoyed the category as it continues to face falloffs in volume or unit sales. The Alcohol and Tobacco Tax and Trade Bureau this past November released its statistical report for tobacco products manufactured domestically last September. A monthly tally showed a decrease of nearly two billion units. A cumulative year-to-date assessment also showed a falloff of more than eight billion units.

For the aforementioned four weeks, cigarette unit sales in all retail channels fell 2.4%.

According to Wells Fargo Securities, volume sales for the fiscal year 2016 will reveal a loss of at least 2%. The market research organization also predicts volume will continue its downward trek by another 3% during fiscal year 2017.

BRAND BREAKDOWN
Some cigarette brands have fared better than others. Wells Fargo Securities revealed Reynolds American’s Natural American Spirit posted an impressive 16% growth in volume for the same four-week period. The brand posted an equally impressive 15.1% for a 12-week period ending Dec. 3, which is topped by 19.6% unit sales growth for the past year. Although pricing for the brand did creep up over the four weeks, at 2.8% it’s below the national average.

Philip Morris USA’s Marlboro also posted positive figures across the board for the same period—dollar sales were up 0.9%, volume was up 1.7% and pricing climbed 2.6%. Perhaps some of that performance can be attributed to the expanding popularity of Marlboro Black. In the same month of November, the Wall Street Journal reported that the less expensive option reached a marketshare of 44.1%, in part due to popularity among Millennials.

“Customers may start trying a lower-priced brand—Pall Mall, L&M, Winston, Kool or fourth tier [cigarettes]—which we try to make similar penny profits on,” said Bailey Lyden, vice president of retail for Brecksville, Ohio-based Truenorth Energy LLC, which owns and operates 110 truenorth c-stores. “One factor that does help is the fact the fuel prices are low, which leads to more disposable income,” he added. “This helps customers absorb the price increases.”

TAXING TOLL
Of course, a dwindling number of smokers are a major contributing factor for the lessening of volume sales.

“The Centers for Disease Control and Prevention reported the adult smoking rate was at a historic low of 16.8% during 2014, down from 17.9% in 2013 and 20.9% in 2008. This clearly shows the smoker base is decreasing year on year and will continue during the future period,” said Manjunath J, a lead analyst for Technavio, a global research firm.

Both analysts and healthcare experts generally agree this downward trend most likely will not reverse itself.

Industry watchers assert new taxes on cigarettes will contribute to further price hikes. Although federal excise tax per pack has been $1.02 since 2010, the average state tax has gone up each year since 2008, reports Wells Fargo Securities. Estimates place the 2016 average state tax increase at 4.5%, with six states issuing higher taxes on cigarettes last year. November ballots in California, Colorado, North Dakota and Missouri each featured proposed cigarette tax hikes; however, only California’s Proposition 56 passed.

Effective April 1, the tax on cigarette sales in the Golden State will change rise to $2.87 per pack from 87 cents per pack.

“As of August 2016, the average tax per retail price per pack is around $2 in the U.S.,” said J. “The increase in taxes always will result in an increase in selling price.”

FUTURE QUESTIONS
All these circumstances—the deflation of the smoking population, manufacturer price hikes and higher taxes—have analysts and convenience store operators wondering if tobacco will finally lose its stake as a top performer. In 2015, tobacco products combined accounted for more than 35% of in-store sales for c-stores, according to the National Association of Convenience Stores (NACS) survey data.

Some analysts project that U.S. consumers will opt for e-cigarettes and vaping devices over combustible cigarettes in bigger numbers, and Big Tobacco companies will continue to invest in these alternatives. While in London for the introduction of IQOS, the company’s heat-not-burn smokeless cigarette, Philip Morris International CEO, André Calantzopoulos, intimated traditional cigarettes could be phased out and replaced by alternative products.

“As tobacco companies see the decline in the number of smokers, they are looking for other products to stay competitive in the marketplace,” said Ray Story, CEO of the Tobacco Vapor Electronic Cigarette Association.

Lyden believes the traditional cigarette consumer will begin using more alternative tobacco items such as e-cigarettes and vape products. However, those options may change as new regulations pressure the market.

“The problem is that the U.S. Food and Drug Administration (FDA) has put such an onerous burden on the e-cigarette category that a lot of companies are going out of business, and that’s stifling growth of new developments or products,” added Story. “We’ve been dealing with the same technology for quite some time. They have to quickly reinvent themselves and come up with next-generation technology.”

Recently, Philip Morris USA submitted a Modified Risk Tobacco Product application to the FDA for IQOS, which is already on sale in Asia and Europe. The federal agency has 60 days to evaluate the application and determine if it will be passed on to the substantive review stage.
When the FDA released its final deeming regulations last year, industry watchers and manufacturers expressed concern about the costly and arduous application process. However, Story holds out hope the incoming administration of a new president and Republican control in the House and Senate could lead to less federal regulations.

“If that happens, we should see new products,” Story said. “Once the technology reaches a level where we can mimic the conventional cigarette experience and euphoria, we will see a decline in conventional tobacco sales like we’ve never seen.”

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