E-Cigs Could Help Reverse The Decline

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Cigarettes can kill you. They can give you cancer, make you spend all your money, and force you to smell bad. But, this little invention may be able to shift this type of public sentiment toward cigarettes to a more light-hearted one.

E-cigs, aka electronic cigarettes, vaporize a liquid that contains nicotine, an assortment of flavors, and propylene glycol (some companies are starting to offer more glycerin solutions as well). This simulates the act of smoking, while enabling you to emit only water vapor, which is less dangerous for your lungs. While this isn't as healthy as not smoking, it still dramatically reduces the negative side effects of smoking.

Big tobacco

The growth in the e-cig industry has been large, big enough to prompt Lorillard (NYSE: LO) to buy out Blu Cigs, one of the bigger e-cig companies, for $135 million. Greater distribution of these e-cigs enabled Lorillard to get $57 million in revenue from e-cig sales in the first quarter.

In 2011, the U.S. e-cig industry was estimated to be worth $500 million per year. Better distribution, more marketing, and a possible change in the social stigma toward smoking (in regards to e-cigs) could easily push this industry to be worth $1 billion within a few years. This pales in comparison to the $100 billion traditional U.S. cigarette industry, but e-cigs have a lot of room to grow, as they appeal to those who also don't smoke cigarettes.

Altria (NYSE: MO) has also stated its intentions to get into the e-cig business. This is huge, because Altria's subsidiary, Phillip Morris, makes the most popular brand of cigarettes in the world, Marlboro. Altria said in it latest earnings call that it would provide an update in June on its future e-cig business, and that sales would most likely start in the second half of 2013.

The long slide and taxes

In the U.S., cigarette sales have been falling for the past four decades. Back in 1960, roughly 50% of Americans smoked cigarettes. Now only 18.5% of Americans smoke cigarettes, and it looks like the trend will keep pushing volume lower for some time. Altria's total sales volume fell 5.2% in the U.S. last quarter (year-over-year), Reynolds saw a 5.6% decline when you adjust for the shorter quarter, and Lorillard fell 2.3%. E-cigs are the only "cigarettes" seeing volume growth.

Cigarette companies like Atria, Lorillard, and Reynolds American (NYSE: RAI) have seen continuous volume declines as less Americans pick up smoking, and in order to replace this they have raised prices.

But, this may get harder to do, with Obama wanting to increase taxes on cigarettes, yet again. In 2009, there was a 9% drop in volume due to the recession and federal cigarette taxes increasing from $0.39 per pack to $1.01 per pack. This was to fund the State Children's Health Insurance Program.

Now, the President wants to increase taxes on cigarettes to $1.95 per pack, which will make it much harder for these players to increase prices to compensate for volume declines. This makes it more important for these companies to grow somewhere else. 


Another company looking at the e-cig market is Reynolds. In its latest earnings, Reynolds management noted that Vuse, its e-cig offering, is growing rapidly.

"Vuse is quite different to what's currently available in this fast-growing category. And we believe that this innovative product will offer adult tobacco consumers a vapor experience that's significantly superior. R.J. Reynolds Vapor Company has exciting plans for the further expansion of Vuse this year. And you'll be hearing more about Vuse soon."

Tobacco companies haven't provided much guidance in regard to the e-cig industry, but it does have a promising future. E-cigs need greater distribution to grow, as they aren't being marketed or distributed the same way as traditional cigarettes. Now that Altria is entering the arena, the three major players (who control roughly 86% of the market in the U.S.) will start to aggressively promote their products. NJOY, another e-cig maker, is also expanding its offering by selling its products at Wal-Mart stores.

E-cigs can help change the social stigma around cigarettes because they are less unhealthy than traditional cigarettes, which could appeal to those who normally wouldn't want to smoke something they see as cancerous. While e-cigs still have nicotine in them, which isn't healthy, they do less harm to your lungs and are less likely to give you cancer. The American Association of Public Health Physicians supports sales of e-cigs to adults because they see them as saving the lives of 4-8 million American smokers who would normally have died due to tobacco use.

Final thoughts

You can't keep raising prices forever, and with the increase in payroll taxes, plus the possibility of a cigarette tax increase, it will become harder and harder to pass through price increases. If cigarette makers keep passing through price increases, they risk losing market share, which leads to a conundrum of operating in a declining market, but not being able to do anything about it, until now. E-cigs, right now, are maybe 1% of the total cigarette market, but should be watched, as they have the possibility to reverse the decline of the tobacco market in the U.S. and save tens of millions of lives.

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