E-Cigarettes to Light Up Tobacco Stocks

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In the media and on the social networks, e-cigarettes seem to be the rage. Celebrities like Leonardo DiCaprio and LeBron James have been spotted using them, without being paid celebrity endorsers. Tobacco companies are realizing this and see this trend as the new growth area for the tobacco companies.

What are e-cigarettes?

An e-cigarette is an electronic inhaler that vaporizes a liquid solution into an aerosol mist, simulating tobacco smoke. E-cigarettes are designed to look and feel like an actual cigarette. The liquid solution contains nicotine to satisfy nicotine cravings.

Analysts forecast that sales e-cigarettes will hit the $1 billion mark this year, double the amount recorded in 2012. The market is still small, considering that $80 billion in cigarettes are sold per year in the U.S., but rapidly growing.

The main selling point for electronic cigarettes is that they don't burn tobacco. A risk for the tobacco companies is cannibalizing their bread and butter – tobacco -- but they see a booming market and if anyone is going to capture their smokers, it's going to be them.

Which company has first-mover advantage?

Lorillard (NYSE: LO) is the third largest tobacco company in the United States. The company has been the most aggressive among the big tobacco companies by buying e-cigarette company blu ecigs. Lorillard bought the company in April 2012 for $135 million. Currently, blu ecigs is the top electronic cigarette company in the U.S. with a 40% market share, and gives Lorillard first-mover advantage among the big tobacco companies. For Lorillard, even though blu ecigs accounts for only 2% of revenues, it comprises 50% of the company's revenue growth.

To ramp up growth at blu ecigs, Lorillard has named James Raporte as the company's new president, replacing founder Jason Healy. Jason Healy will move to a consulting role in product development and marketing. Raporte has over 30 years experience in the tobacco industry and will use that experience to increase the company's distribution and marketing. So far blu ecigs are available at more than 80,000 retail locations in addition to its online presence. Raporte is tasked with using Lorillard's relationships with distributors and retailers to expand the reach of blu ecigs.

Which company looks to get into the market in a big way?

Reynolds American (NYSE: RAI) is the second-largest tobacco company in the U.S. Executives at Reynolds American are touting their new electronic cigarette Vuse as a game changer. The company plans to be a major player in the market in a short amount of time and is rolling out its expansion first in Colorado.

The advantage to Vuse, according to the company, is that its digital technology creates a perfect puff every time. The digital technology is designed to maintain the consistency of the nicotine vapors that the user is inhaling. It is marketed as a tobacco product and not a smoking cessation device. The company is going after the tobacco market and wants to provide a product that can convert smokers once they try the e-cigarette. An estimated 30% of smokers have tried an e-cigarette, but the conversion rate has been low. Reynolds American feels that a superior product will convert the smokers to its Vuse electronic cigarette.

Where is the biggest tobacco company in this market?

Philip Morris International and Altria Group (NYSE: MO) produce the most popular cigarette in the world, Marlboro. Altria Group has the U.S. market and Philip Morris has the entire market outside the U.S. Philip Morris International was spun-off from Altria Group in 2008.

Altria Group is the market leader in smokeless tobacco products, but neither company currently has an e-cigarette in the marketplace. That is about to change, as Altria Group announced in April that its Nu Mark subsidiary will roll out an electronic cigarette in the second half of this year. Altria's entry into the market has the other players concerned.

<table> <tbody> <tr> <td> </td> <td> <p><strong>Philip Morris</strong></p> </td> <td> <p><strong>Altria</strong></p> </td> <td> <p><strong>Lorillard</strong></p> </td> <td> <p><strong>Reynolds</strong></p> </td> </tr> <tr> <td> <p><strong>Market Cap</strong></p> </td> <td> <p>$150.61 billion</p> </td> <td> <p>$72.41 billion</p> </td> <td> <p>$16.47 billion</p> </td> <td> <p>$26.16 billion</p> </td> </tr> <tr> <td> <p><strong>Revenues</strong></p> </td> <td> <p>$31.51 billion</p> </td> <td> <p>$17.48 billion</p> </td> <td> <p>$4.70 billion</p> </td> <td> <p>$8.25 billion</p> </td> </tr> <tr> <td> <p><strong>Gross Margin</strong></p> </td> <td> <p>0.67</p> </td> <td> <p>0.57</p> </td> <td> <p>0.55</p> </td> <td> <p>0.51</p> </td> </tr> <tr> <td> <p><strong>EBITDA</strong></p> </td> <td> <p>$14.80 billion</p> </td> <td> <p>$8.27 billion</p> </td> <td> <p>$2.25 billion</p> </td> <td> <p>$3.03 billion</p> </td> </tr> <tr> <td> <p><strong>Operating Margin</strong></p> </td> <td> <p>0.44</p> </td> <td> <p>0.46</p> </td> <td> <p>0.47</p> </td> <td> <p>0.35</p> </td> </tr> <tr> <td> <p><strong>Net</strong> <strong>Income</strong></p> </td> <td> <p>$8.72 billion</p> </td> <td> <p>$4.36 billion</p> </td> <td> <p>$1.20 billion</p> </td> <td> <p>$1.51 billion</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>17.71</p> </td> <td> <p>16.73</p> </td> <td> <p>14.07</p> </td> <td> <p>17.80</p> </td> </tr> </tbody> </table>

Foolish assessment

The market for electronic cigarettes looks set to become the next growth area for the tobacco giants. Lorillard and Reynolds American have a head start on Altria and Philip Morris, but the latter's financial strength and marketing muscle can allow them to catch up quickly. As more smokers embrace the non-smoking trend, look for them to follow the example and embrace electronic cigarettes.

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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