Tobacco Tailwinds Beginning to Moderate

RESTON, Va. — The tobacco industry has been riding high the past year or so, and although this should continue through 2016, the tailwinds are beginning to moderate.  

The industry has been enjoying an upswing at the same time as the core tobacco consumer has been enjoying an upswing — and that's no coincidence, Nik Modi, managing director and analyst with RBC Capital Markets LLC, explained during a July 19 webinar hosted by the Convenience Distribution Association (CDA), the trade organization that works on behalf of U.S. convenience products distributors.  

"The economic environment has favored the tobacco industry and I think that will continue as the backdrop for the remainder of the year," Modi said, noting that housing starts have sustained momentum and the job environment looks good for the core convenience store tobacco consumer. Wages and salaries also have improved outside of the minimum wage movement — a movement Modi believes could hurt job growth. 

"What we are seeing now is natural wage growth through supply and demand," he said, adding that as the number of long-haul truck drivers declines, the salary for them will rise.

That being said, the political environment is leading to some moderation of consumer confidence. However, even with the unknowns swirling around the presidential election, consumer confidence should sustain through the election, Modi stated during the "Tobacco 2016: State of the Union" webinar.

What about tomorrow's consumer? The convenience store industry is in a "really good spot. Gas prices are still not a headwind, employment levels are improving, and we are seeing wage inflation,"  he said.

He predicts, "we will keep bumping along this way" for the next five years even, as wealth becomes more bifurcated. "It's not the rich vs. the poor. It's now the super rich vs. everybody else."

TOBACCO SEGMENT TRENDS

Looking at the specific segments of the c-store tobacco business, the economic tailwinds have led to premiumization in the cigarettes segment. Adult smokers are trading up to premium brands, while dual users are migrating back to cigarettes because they can afford them, according to Modi.

Cigarette industry volume continues to be ahead of normalized trends. Still, while things are good now as the industry laps a lot of the tailwinds from a year ago, Modi believes cigarette industry volume could be down between 3 percent and 4 percent in the fourth quarter of 2016 and down roughly 2 percent for the year.

"People aren't smoking more. You are seeing non-tracked consumers coming back to tracked channels and you are seeing dual users going back to cigarettes," he said.

As an aside, menthol cigarettes will continue to gain share as adult smokers under the age of 30, who lean toward menthol, get older, Modi pointed out. 

As for electronic cigarettes, the segment has come down from its peak in 2014. Fewer retailers are carrying e-cigarettes today than two years ago, he explained, and the product offerings are still not fully meeting consumer needs. In addition, retailers are reducing e-cigarette SKUs and Internet searches point to a decline in consumer interest.

"My personal point-of-view is none of these products are ready for primetime. We haven't seen real cigarette users become real e-cigarette users. That will take R&D [research and development], and that takes time," he said. "...Until vapor-only numbers go up significantly, this category will continue to bump along the bottom."

Despite this, Modi has no doubt that sometime in the future it will be a real category — just not now. 

As for the Food and Drug Administration's (FDA) final deeming rule and its regulations, Modi's initial read and feedback from industry contacts suggests the regulations are as bad as feared and likely to create longer-term barriers to entry for the Big Tobacco players. Notably, as of Aug. 8, no new vaping product will be allowed on the market, effectively freezing innovation, he pointed out. 

"The FDA created unintended consequences by creating such a high hurdle for compliance. It will stifle innovation, which is what the category needs," Modi observed.

Overall, total tobacco declines are moderating — down about 1 percent — and they will be down slightly by the end of the year, he forecasted.