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    There's Several Reasons to Be Bullish on U.S. Tobacco Sector

    Consumers continue to trade up to premium brands.

    NEW YORK — Wells Fargo Securities LLC's latest tobacco survey indicates the category remains healthy and cigarettes will count 2016 as another good year.

    The Tobacco Talk poll, which surveys retailer and wholesalers representing more than 30,000 convenience stores in the United States, found that the overall tobacco environment remains healthy.

    According to Bonnie Herzog, managing director of tobacco, beverage and convenience store research at Wells Fargo Securities, strong cigarette manufacturer net price realization hovered around 5 to 6 percent in the second quarter driven by favorable macro tailwinds supporting a strong adult tobacco consumer, continued up-trading to premium brands, and a rationale, but slightly more competitive environment especially between value and deep discount brands as price gaps widen.

    In addition, according to the survey, the industry continued to see moderation in cigarette volumes, which declines 2 percent in the past quarter. This could point to full-year 2016 industry volumes outperforming historical averages declines of 3 to 4 percent, she said.

    Also a factor in the overall health of the tobacco environment is an increasingly constructive outlook on vapor as top tier players should ultimately benefit from the Food and Drug Administration's final deeming e-cigarette regulations, Herzog noted. 

    "We remain bullish on the U.S. tobacco sector and believe the risk/reward is favorable ahead of both Reynolds American Inc.'s (RAI) and The Altria Group's second-quarter results based on consistently positive feedback on their top brands from our retailer contacts," she said.

    RAI releases its results on Tuesday, July 26 and Altria follows on Wednesday, July 27.

    Looking at brands, Tobacco Talk found that retailers remain optimistic on Newport's potential, expecting the cigarette brand to gain roughly 125 basis points of incremental share this year — more than double the share Newport gained in full-year 2015.

    "We believe this reflects Newport's faster growth as the full benefits of retailer shelf resets kick-in, driving greater shelf space as part of RAI's Everyday Low Price (EDLP) program as well as share gains for RAI's entire portfolio," Herzog said.

    She noted one retailer said, "inclusion in the EDLP program almost guarantees growth" for Newport. 

    However, offsetting Newport growth is downtrading pressure on Pall Mall as the price gap widens to deep discount brands. 

    "Regardless, we believe RAI remains strongly positioned for share gains, leveraging Newport to drive faster growth across its entire portfolio and meaningful margin expansion," Herzog said.

    As for Altria, Wells Fargo Securities remains encouraged by retailers' continued positive feedback on Philip Morris USA's Marlboro app. According to Herzog, 67 percent of adult tobacco consumers are using the app in stores vs. 63 percent in April and 51 percent in December.

    "We continue to believe Altria is ahead of its peers in its use of technology and leveraging digital to modernize engagement with consumers," she added.

    The No. 3 player, ITG Brands LLC, continued to lose ground but could see a boost from revamped packaging of its Winston cigarette brand. Notably, nearly 60 percent of retailers expect the company to lose cigarette share, citing "an uphill battle" for the company, Herzog explained.

    In addition, approximately 75 percent of retailers surveyed said that ITG Brands lost the most shelf space this year will all shelf resets for the year completed.

    "We continue to believe ITG Brand's woes largely stem from a lack of brand focus and loss of leverage to powerhouses RAI and Altria. Although Winston promos have intensified, retailers aren't seeing a difference," Herzog said. "Most believe a major strategic pivot is in order for ITG Brands."

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