Can E-Cigarettes Be a Life Saver for Tobacco Companies?

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The tobacco manufacturing industry has been under deep regulatory scrutiny for quite a long time. Higher taxes, increasing health concerns, and smoking bans in public places have affected sales in the big U.S. companies. Consumption of tobacco products fell 27% from 2000-2011 according to Centers for Disease Control and Prevention. Although the e-cigarette market represents only a fraction of the U.S. tobacco sector, sales have been increasing over the last few years amid the health issues widely known. E-cigarettes vaporize nicotine liquid, making it inhalable and avoiding the carcinogenic elements present in traditional cigarettes enabling indoor consumption.

New Players

Some U.S. companies are trying to enter this new prosperous market. One of them is Reynolds American (NYSE: RAI), which released its first battery-powered e-cigarette. The company has 27.6% of the total market share of traditional cigarettes. With its Vuse brand, Reynolds has redeveloped the e-cigarette and is investing heavily in marketing campaigns to increase awareness in the consumer populace. This way, it is attempting to differentiate from the hundreds of other brands, mainly made in China. The estimated market for this product is at $1 billion (of a total of $90 billion in the traditional channel), but could be a great bet for the future in this declining industry.

Reynolds American's stock price is not feeling the general sales deceleration present in the industry, as it has gained more than 14% so far this year. It is trading above the industry average at 18 times P/E ratio and 2.9 times PEG ratio, which could indicate the stock is overvalued. It is also under-performing regarding the return on assets at 9 times, while the industry average stands at 14.7 times. The same goes for the return on equity at 27 times, versus the industry average of 108 times. Entering the e-cigarette market could be a game-changer for Reynolds to return to a growth path similar to its peer group.

Another company that does not want to be left behind is Lorillard (NYSE: LO). This was the first of the big tobacco companies to enter this market through its 2012 acquisition of Blu Ecigs for $135 million. The company has 12.7% of the traditional cigarettes market share. The Blu Ecigs brand is reaching $50 million in revenue, according to the company’s presentation, and claims to be the leading brand in the sector. The company is investing in marketing campaigns and retail expansions for its product.

Lorillard’s stock has also gained in the past year. It increased more than 5% amid some ups and downs. It is trading at 14 times P/E, a bit lower than the industry average, and its PEG ratio is 1.2 times. The company’s return on assets is 34 times above the industry average. This company could be a good bet to enter the tobacco industry and gain exposure to the e-cigarette sector.

Finally, the biggest player in the traditional cigarettes market, with 49.2% of market share, will also enter the e-cigarette industry this year: Altria Group (NYSE: MO). The producer of Marlboro will certainly heat up the competition, as it is expected to join this market with its own e-cigarette brand. Altria is aware that the smokeless products category has been growing and does not want to lose a piece of this market, one that looks promising regarding future prospects. The company reported a 7% growth from 2011 to 2012 in smokeless products, totaling $959 million.

Altria’s share price has surged 6.7%, highlighting that tobacco companies are far from dead. The company has a valuation similar to Lorillard, as it is trading at a 16.5 times P/E ratio, which is in line with the industry, and has a PEG ratio of 2.1 times. Its return on assets is lower than the industry average and stands at 11.5 times, but it has an attractive return on equity of 122 times, the highest of the peer group. Growth prospects for Altria seem bright with the development of its own e-cigarette device, and this is a good opportunity to channel that growth.

Possible obstacles: the feared regulation

It first started as a niche product, but as sales are increased, it drove the attention of the media and possible regulatory measures. This could be a problem for these companies as this could lead to taxation and other regulatory measures that could hurt sales margins. Currently, the industry is in a grey area in which there are no strict regulations, but a mild guidance from the U.S. Food and Drug Administration. However, some states have banned the sale of this product to minors as well as the use of e-cigarettes indoors (New Jersey, North Dakota and Utah).

If regulated and taxed, this could make it very difficult for consumers to adopt the new product, as prices will be nearer to traditional cigarettes. But, be aware of this market as tobacco companies have huge lobby maneuvers that can delay new regulatory measures.

The outlook

The e-cigarette market is consolidating as many big brands and manufacturers are betting their stakes for future growth. Sean Parker, the Sillicon Valley entrepreneur who co-founded the music sharing site, Napster, and a group of hedge funds are investing $75 million in an e-cigarette manufacturer called NJOY, and this news has renewed the attention in this sector. Companies are trying to get profits before new regulatory schemes are established, and the outlook for this market is massive: about one of five Americans smokes traditional cigarettes.

Altria has been the best-performing stock of the past 50 years, but as the number of smokers in the U.S. continues to steadily decline, is Altria still a buy today? To find out whether everyone’s love-to-hate dividend stock is a savvy investment choice or a hazard to your portfolio, simply click here now for access to The Motley Fool's premium research report on the company.


Vanina Egea 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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