Reduced Risk Tobacco Products Hold Big Promise

In a recent NATO webinar, Goldman Sachs' Bonnie Herzog noted the backbar is still a driver of c-store traffic, despite challenges.
The tobacco backbar in a convenience store

NATIONAL REPORT — Confusion, caution, holding pattern, promise — this is what currently circles the tobacco and nicotine category.

In the second of three tobacco-related webinars sponsored by the National Association of Tobacco Outlets (NATO), Bonnie Herzog, senior financial analyst at Goldman Sachs, highlighted "Current Trends & What's Ahead in Tobacco and Nicotine," covering an overview of nicotine market trends, what's top of mind in individual nicotine segments, and longer-term industry concerns and opportunities.

"Nicotine categories are still a very important driver of c-store traffic and profits," with approximately 90 percent of cigarette sales taking place in the channel, Herzog said.

In terms of gross margins, tobacco/nicotine is in the top three in-store categories, after foodservice and packaged beverages, according to Herzog, who added that cigarettes and other tobacco products (OTP) drive approximately 20 percent of gross margins inside the store.

In Goldman Sachs' October 2022 Nicotine Nuggets survey, retailer and wholesaler respondents said they were "quite cautious" about the category — citing broad-based inflationary pressures, lower discretionary income, lower usage and increased downtrading.

Herzog pointed out that the macro environment is still uncertain and negatively affecting the category. "Gas prices have calmed down, but remain a near-term headwind to adult tobacco/nicotine consumers," she said.

Cigarette Concerns

According to the numbers, cigarette volume declines are accelerating, driven by inflation and list price increases. What's more, the relative price gap between a pack of Marlboro and the lowest-priced brand is at 40 percent — "the highest it's been," according to Herzog.

"We'll be watching to see whether deep discount cigarette manufacturers also move on price; if deep discount doesn't move, the relative price gap could widen further," she said.

As the Nicotine Nuggets survey found, downtrading remains a top concern among retailers and wholesalers. Respondents reported fewer cigarette purchases per trip and shifts to single packs. The good news: Strong promotional activity and loyalty programs are mitigating downtrading to some extent, Herzog maintained.

"Another interesting callout many of you highlighted is a shift to more non-combustible alternatives, more affordable options," she said. "This will probably continue as cigarette pricing continues to stay high."

And the dip in cigarette volumes may continue, according to Herzog, who added that Goldman Sachs expects volumes to be down 4 percent for 2022 and about 3.9 percent for 2023 "due to stronger elasticities, inflationary headwinds, price increases, increased polyusage, and downtrading to nicotine alternatives."

Breaking Down the Backbar

Drilling down into individual segments beyond cigarettes, Herzog pointed out that modern oral nicotine "looks promising, but is still in the early days."

The segment is approximately 1.7 percent of the U.S. tobacco market and growing. It has attractive demographics of younger, more affluent, better educated, urban consumers. To increase margins and profitability, modern oral will need to get past the investment period, she explained.

The e-vapor market is in a holding pattern, as Food and Drug Administration (FDA) decisions remain pending on major premarket tobacco product applications (PMTAs), keeping the category in limbo, according to Herzog. Vuse has taken over Juul as the No. 1 electronic cigarette brand. Juul's performance has declined following confusion created by the FDA's marketing denial order.

Retailers and wholesalers are cautious on e-cigarette and vapor growth, broadly driven by the FDA's pending PMTA decisions. The good news is the FDA's expected timeline to complete all remaining reviews is by June 30, 2023. 

Regarding the potential cigarette menthol ban and nicotine cap levels in cigarettes and other combustibles, Herzog reminded the webinar audience that the FDA rulemaking process is a multiyear and complex process, given unintended consequences and science requirements.

"We have to wait to see where it goes," she said.

Despite the questions and challenges surrounding the tobacco and nicotine category, Herzog concluded that she is "optimistic, but cautiously so, for the overall nicotine category given inflationary pressures and pressures on consumers' wallets. I'm very excited about the ongoing conversion to reduced risk products. I just wish it could happen at a faster pace and maybe it will, depending on the FDA."