Tag Archives | Big Tobacco

Reader Comment: Are E-Cigarettes Getting Stubbed Out?

In response to my article “Are E-Cigarettes Getting Stubbed Out?” and specifically to my comment that slowing imports could be a sign of slowing product demand, Pascal Culverhouse of Electric Tobacconist wrote a thoughtful reply. Mr. Culverhouse can certainly speak with authority on the subject; he happens to be the proprietor of an online vaping retailer based in the UK. He notes that his sales continue to grow at a rather brisk pace of 10% per month.

Here’s my take on your imports theory:

Two years ago, the model (in the US & UK) was that people would buy cigarette-style ecigs, followed by unique cartridge refills which weren’t interchangeable across brands. These cartridges were usually made in China, meaning that the majority of the products needed to be imported.

Fast forward two years and the bottom has fallen out of that side of the market. From occupying around 80% of our sales this time last year, it is now around 20%. Nowadays people are more interested in the ‘tank-style’ liquid kits which can be filled up with any e-liquid of their choosing.

This fact has the following implications:

  1. Liquid can be blended anywhere and the public is starting to favour domestically-made stuff (instead of bulk-made Chinese liquid), hence reduced imports.
  2. Tanks last longer, so less hardware is required. Again, meaning less importation of hardware.
  3. Brands find it harder to tie the customer down because the ‘cartridge refill’ model is all but dead.

There have been many reports about the slowing of the industry, but my feeling is that these reports come off the back of skewed statistics. If you measure the growth of, say, the five biggest brands in the US/UK then you will see their growth curve slowing (this is what we have seen among the major brands we carry – blu, NJOY, VIP, Vapestick etc), but the industry itself is dispersing and growing at a rapid rate.

So from an investment point of view, Big Tobacco has its work cut out, as the ecig industry is becoming more like the wine industry where from one day to the next a customer might want to try a ‘tipple’ of Five Pawns Bowden’s Mate, and then the next they might want some NJOY Samba Sun. I can’t see how punters are going to be tied down in the way they are with tobacco. Vaping is now akin to having a wine glass and the freedom to fill it up with whatever wine you want [Emphasis Charles] — bad news for anyone looking to dominate the industry.

I genuinely feel we are one of the few companies who can truly offer an insight into the market, as we are the only company which covers everything from Big Tobacco, to major independents to quirky start-up brands.

Thanks to Pascal for his thoughtful comments.

I reasoned in my article that Big Tobacco might be better positioned than the smaller upstarts to withstand the inevitable legal and regulatory onslaught facing the industry. But beyond this, Big Tobacco really has no clear competitive advantage over the upstarts, and Pascal’s experience would seem to confirm this.

For those still unfamiliar with the ins and outs of electronic cigarettes, Pascal’s site will give you a good sampling of the market: www.electrictobacconist.com.

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Are E-Cigarettes Getting Stubbed Out?

Call it the revolution that wasn’t, but it looks like e-cigarettes might be getting stubbed out. Global trade data site Panjiva reported recently that shipments of e-cigarettes entering US. ports have been declining since late 2013:

Shipments of e-cigarettes entering US ports – by quarter


Shipments of E-Cigarettes Entering US Ports

Meanwhile, shipments of actual tobacco—you know, the carcinogenic stuff that kill you—have actually been on the rise:

US Imports of Tobacco – Dollar Value by Quarter

US Imports of Tobacco (Dollar Value by Quarter)

US Imports of Tobacco (Dollar Value by Quarter)

Now, before I go any further, I should point out a couple things. These data sets are looking at imports, not total sales or production. Plenty of e-cigarette paraphernalia gets produced right here in the USA, and America is also a major grower of tobacco. Sales e-cigarettes and accessories have roughly doubled over the past two years to about $3.5 billion.

So, import data clearly does not tell the whole story. But it may give us advanced warning of a pending slowdown. If anything, the soaring U.S. dollar should have caused a nice bump in shipment imports, which clearly has not happened. And looking at the bigger picture, lower shipments today mean than retailers might be projecting lower sales tomorrow.

What’s the story here?

Part of it is regulation. When e-cigarettes were first introduced, they existed in something of a regulatory limbo. It wasn’t exactly clear which, if any, of the myriad of existing tobacco laws applied to e-cigarettes, and “vaping” had become a legal way to smoke in public places where traditional cigarettes are banned. They were also an easy way for underage teenagers to get their nicotine fix, as there were initially no age restrictions on sale. But those regulatory loopholes are quickly getting closed. At least 42 states now ban sales of e-cigarette products to minors, and bills are being considered in Massachusettes, North Dakota and even in lax-regulation states like Texas and Montana.

Now, I’m not necessarily a fan of government regulation. If I had my way, the e-smokers would be left to exhale their water vapor in peace. But given the aggressiveness of all levels of government towards tobacco products–everything from Washington DC down to the local neighborhood association–we should have known it was just a matter of time before we saw an organized crackdown. Though hard data is hard to come by, in most cities the existing rules that ban traditional cigarette smoking are getting applied to e-cigs. And the FDA is planning on releasing a set of new e-cig regulations in June that will probably come close to treating e-cigs like traditional cigarettes.

This is not necessarily a death knell for e-cigs. After all, cigars enjoyed a major boom in popularity in the 1990s and 2000s even while the anti-tobacco movement was in full swing. But it does suggest that the notion that e-cigs would be the savior of Big Tobacco is ludicrous. As I wrote late last year, rather than save Big Tobacco, cheap e-cigs filled with generic refill fluid are a lot more likely to speed up its demise. And to really put things in perspective, Altria’s (MO) annual revenues are more than five times larger than the most generous estimate of the revenues for the entire vaping industry. It’s hard to see vaping replacing those lost revenues.

Ironically, an FDA crackdown on vaping could play into Big Tobacco’s favor. Altria, Reynolds American (RAI) and their peers have the experience and legal budgets to navigate a regulatory onslaught better than newer e-cig upstarts. While I don’t believe that Big Tobacco has played its hand well with the rise of e-cigs (see “Big Tobacco Botches the E-Cig Name Game“), they will probably end up being the last men standing.

Is there a trade here?

Probably not. Big Tobacco stocks are surprisingly expensive at today’s prices. Altria and and Reynolds American trade for 17 times and 18 times their respective 2015 expected earnings and at the lowest dividend yields in memory. And remember, these are companies selling products in terminal decline.

My advice is to sell Big Tobacco. There are better–and safer–income options to be found elsewhere.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.


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Big Tobacco Launches a “Safer” Cigarette. It Won’t Stem the Decline

You have to hand it to Big Tobacco.  As an industry, it’s a survivor.  It’s doing everything it can to reinvent itself in a world in which its core product—cigarettes—becomes more of a social pariah with every passing year.  Let’s take a look at what Big Tobacco is up to and what it might mean for investors in Big Tobacco stocks.

Reynolds American (RAI) made headlines this week by announcing the planned launch of the Revo, a “safe” cigarette that heats tobacco rather than burning it. Philip Morris International (PM) has a similar product in the works for sale overseas, which I highlighted earlier this year.

Yogi Berra, the Hall-of-Fame  New York Yankee catcher, might have called this a case of déjà vu all over again. Reynolds American launched a similar product two decades ago, but it never amounted to much. (Yogi Berra, incidentally, was once a celebrity endorser of Camel cigarettes, a Reynolds American brand.)

E-cigarettes work in roughly the same way. Tobacco is heated rather than burned, and the smoker inhales a relatively harmless nicotine-infused vapor rather than a cloud of carcinogenic smoke. The benefit of the Revo is that it looks and feels more like a real cigarette than its electronic competitors do. And while it’s far too early to be breaking down profitability, I think it’s safe to say that Revo is a better profit model for Big Tobacco. Revo is a real, branded cigarette sold in a pack that can be sold at a premium, not a generic bottle of refill fluid.

I’ve been skeptical of e-cigarettes for a long time. Yes, they could relight Big Tobacco’s prospects. But they are just as likely to speed the decline of traditional cigarettes, and Big Tobacco has no durable competitive advantage in the e-cigarette marketing free-for-all.

So, are Revo and its competitors the answer for Big Tobacco?

Not so fast.  One of the reasons that Revo’s predecessor failed was that multiple states sued Reynolds American for claiming that it was less harmful than a traditional cigarette.  Those claims were unsubstantiated by real studies. So, Reynolds will have to be careful in how it markets Revo this time around the wrath of regulators.  But neutering the marketing will make it a lot harder to build a following among smokers.

In a best case scenario, Revo might steal a little market share from traditional cigarettes and slow down the long-term decline of the industry.  But that is the best case, and even under this scenario Big Tobacco volume sales would continue to decline.  The more likely scenario is that Revo is a marketing flop that is forgotten in a year or two.

From the tone of this article, you might think that I’m a dyed-in-the-wool Big Tobacco bear. Nothing could be further from the truth. At the right price, industries in terminal decline can be great investments if management focuses on returning value to shareholders via dividends and buybacks. But the key is “at the right price.”  And right now, Big Tobacco stocks are expensive.

Reynolds American trades for 21.5 times trailing 12-month earnings…and at a cyclically-adjusted price/earnings ratio (the “CAPE” or “Shiller P/E”) of 26.0 times earnings.  The numbers for domestic rival Altria (MO)  are 22.5 and 24.3, respectively.  As a point of reference, the S&P 500 trades at 20.0 times trailing earnings and 26.6 times CAPE—a valuation that is 60.2% above its long-term average.

In other words, U.S. stocks are very expensive by historical standards, and Big Tobacco stocks are only a hair cheaper that the broader market.  And again, this is an industry in terminal decline—which should be trading at a substantial discount to the market average.

In the interests of full disclosure, I have very small positions in Altria and Philip Morris International that I have held for years in a long-term dividend reinvestment portfolio.  But I’m not adding any new funds to either, and I recommend steering clear of Big Tobacco at current prices.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Lorillard is a Bad Deal for Reynolds American Investors

And then there were two.  Two of the three remaining American “Big Tobacco” companies announced today that they would be merging: Reynolds American (RAI) will be buying Lorillard (LO) for $27.4 billion, including debt assumed.

Reynolds and Lorillard combined have sales of $13.3 billion and a market cap of $55.3 billion as of yesterday’s prices, leaving Altria (MO), the maker of Marlboro and other iconic brands in the number one spot.  Altria has annual revenues of $17.7 billion and sports a market cap of $84.5 billion.  Breaking it out by market share, the new Reynolds will control about 42% of the U.S. cigarette market, Altria will control about 51%, and smaller and foreign brands will make up the rest.

I’ll be brutally frank here: I question the value of this merger.  Reynolds is paying a high price for what is, we should remember, a business in terminal decline.  As of yesterday’s close, Lorillard shares traded for 21 times earnings and at a dividend yield of only 3.8%—quite low by the standards of a tobacco company.

Let me be clear on something: I’m not necessarily opposed to buying stocks in industries that are in terminal decline.  Under the right set of conditions—barriers to new competitors, dominant market position, minimal need for new capital investment, ample cash flows for dividends and buybacks, etc.—stocks with shrinking businesses can be excellent investments.

But the key here is price.  An investment in a shrinking company only makes sense if it is priced at a deep discount to the broader market.  And Lorillard—as implausible as this is—trades at a slight premium to the S&P 500.

Forgetting price for a moment, the Lorillard deal also brings with it regulatory risk.  85% of Lorillard’s sales come from its menthol brands, and these have become a lightning rod in recent years.  The U.S. Food and Drug Administration has already banned most flavored cigarettes and reported last year that it believes menthol cigarettes contribute to youth smoking.

Reynolds is effectively making a $27.4 billion bet that the FDA will leave menthol cigarettes alone.  That seems reckless to me; it’s a bet with modest upside and potentially disastrous downside.

Is there a trade to make here?

Yes: Sell Reynolds if you own it and move on.

I’m not the biggest fan of tobacco stocks at current prices.  I have shares of Altria and Philip Morris International (PM) that I have owned for years as part of a dividend reinvestment strategy, but I haven’t invested any significant new money in these positions in years because I see better income options elsewhere, such as in REITs.

If you feel you must own tobacco stocks, then I would go with Altria or Philip Morris International.  While neither are fantastic bargains these days, neither have the potential regulatory time bomb that Reynolds does in its exposure to menthol.  At time of writing, MO and PM sport dividend yields of 4.5% and 4.1%, in line with RAI’s 4.3%.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 


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It Just Keeps Getting Worse For Big Tobacco

The bad news just doesn’t stop for Big Tobacco.  The industry is no stranger to smoking bans, punitive taxation, and crippling lawsuits, particularly in the United States.  But life continues to get more difficult in much of the rest of the developed world too.  Let’s take a look at new developments coming out of the UK.

In June, the British Medical Association (“BMA”) voted in favor of banning cigarette sales to anyone born after 2000. The BMA is a doctors’ union, not an arm of the government, so its proposed ban has no legal teeth to it.  But this is the same BMA that successfully lobbied the British government to ban smoking in public places.  The UK’s Health Act of 2006, supported by the BMA, made smoking illegal in all government buildings, workplaces, and restaurants.

Whether the ban on British would-be future smokers passes or not, the handwriting is on the wall.  Western governments, saddled with unaffordable health costs, will not be letting up the pressure on Big Tobacco any time soon. And it’s starting to show up in earnings reports.  Last week, Philip Morris International (PM)  trimmed its earnings outlook for 2014, citing, among other factors, one of the most potentially devastating regulatory developments in decades: Australia’s plain packaging rules, which require all cigarettes, regardless of brand, to be sold in plain, white boxes with standardized font on one side…and a picture of a person dying of cancer on the other.

I wrote about Australia’s new rules a year ago (see “Judge Tobacco Stocks by Their Cover”), predicting that they would be very damaging to Big Tobacco’s branding power.  As I wrote then,

Longtime chain smokers light up for one very obvious reason: They are addicted to the nicotine. But for casual smokers — those who light up while drinking, for example — the experience matters, too.

I call it the “Rebel Without a Cause effect” … the devil-may-care image that goes along with smoking is part of what makes it pleasurable.

There is a certain appeal to Altria’s (MO) familiar Marlboro logo. But there is most certainly no romance in a plain white box with a picture of a diseased lung on the flip-side.

 Sure enough, Philip Morris CEO Andre Calantzopoulos noted that the rules were having an ill effect on Australian sales:  “With plain packaging, adult smokers do not quit more or smoke less. They do, however, appear to down-trade much more readily to lower price, lower margin brands and illicit products.”

The UK and Ireland are also seriously considering plain packaging laws, and several other countries are reported to at least be toying with the idea.

Even “vaping,” or the smoking of e-cigarettes, is under attack.  The U.S. Food and Drug Administration announced in April that it would be begin regulating electronic cigarettes.  And overseas, Britain’s equivalent of the FDA will begin regulating e-cigs as of 2016.  E-cigarettes—which are safer than traditional cigarettes because of the absence of carcinogenic tar—are actually illegal in Brazil, Norway and Singapore.

Remember, e-cigs were supposed to “relight” Big Tobacco as the transformative product that saved the industry from secular decline.  So much for that idea.

Where does Big Tobacco go from here?

I’m not predicting wholesale bankruptcy any time soon, and in fact, I still own shares of PM and  MO in a few dividend-focused portfolios I run. But I believe it’s important to be realistic here.  The industry’s ace in the hole—rising demand overseas to offset long-term decline in the developed world—is looking less and less reliable.  Even China—the world’s largest tobacco user by a wide margin—moved to ban indoor public smoking earlier this year.  It is only a matter of time before the regulatory vice is tightened further.

If you own tobacco stocks as part of a diversified dividend portfolio, I think it’s fine to continue holding your positions and to reinvest the dividends.  But I wouldn’t put significant new money into Big Tobacco any time soon, or at least not at today’s prices.  PM and MO trade for 16 and 19 times earnings, respectively, compared to an P/E of about 20 for the S&P 500.  Given the lousy growth prospects and the virtual guarantee of continued regulatory attacks, I would only recommend making new purchases of Big Tobacco stocks at much wider discounts to the market.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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