Big tobacco can no longer name its price
Summary
Shifts in the U.S. tobacco market are trickier for expensive brands like Marlboro to navigate than cheaper rivals.
America’s cigarette market is in flux, and new smoking habits threaten to singe makers of pricey brands the most.
One of the attractions of investing in tobacco stocks has been cigarette manufacturers’ amazing ability to continuously grow their profits through price hikes, even though the industry is in long-term decline. This helps cigarette companies pay generous dividends to their shareholders.
In a potential red flag, though, cigarette profits at Marlboro-maker Altria fell from a year earlier in its latest quarter. The company wasn’t able to raise prices enough to offset falling sales. The same thing happened in 2018, when Juul e-cigarettes were rapidly grabbing market share from old-school smokes.
The problem for tobacco companies is that the American cigarette market is shrinking faster than anyone expected. Over the three months through September, the number of sticks sold across the industry fell 8% year-over-year, almost double long-term averages. Smoking trends became less predictable during the pandemic and never settled back to normal.
Something has happened to underlying demand. Altria thinks illegal disposable vapes are now taking customers from cigarette companies. The market for these vapes is booming, growing 20% so far this year according to Barclays estimates. If Altria is right about the trend, better enforcement by the Food and Drug Administration could help to stabilize cigarette volumes.
But the tobacco industry’s customer base is also getting older and dwindling as fewer young people take up smoking. Two decades ago, a fifth of U.S. smokers were aged 50 or older. This figure will reach 50% by 2030 according to Vivien Azer, analyst at TD Cowen.
Expensive cigarettes such as Marlboro or Newport, which is made by British American Tobacco, face a double whammy. Smokers have also become much more sensitive to prices as inflation remains sticky, leading to widespread switching to cheaper brands.
The difference between a $5 and $9 pack of cigarettes is partly the quality of the tobacco blend. But smokers of “premium" cigarettes also pay through the nose for branding and posher packaging such as embossed lettering and thick cardboard boxes that feel more luxurious. At a national average of $8.77-a-pack including taxes, Marlboro is now 43% more expensive than cheaper rivals, according to Altria data, compared with 31% five years ago.
This fat price gap is a gift to smaller brands that are grabbing market share. According to Vector Group, whose Montego brand is now the biggest discount cigarette in America, volumes of the cheapest cigarettes rose 15% over the 52 weeks through September, compared with an 11% decline for the priciest smokes. Imperial Brands is also benefiting from smokers trading down. The London-listed company has grown its share of the U.S. cigarette market from 7.7% in late 2018 to 9.2% today, according to Bernstein estimates.
Big tobacco companies are scrambling to hang on to smokers. BAT cut the price of its Lucky Strike cigarettes by 50% in 2021. The strategy appears to be working, as Lucky Strike has grown its share of the U.S. market to 4% from almost nothing in two years, based on Bernstein analysis. BAT is still losing share of the U.S. market overall, however.
Altria won’t do anything as dramatic. Thirty years ago, the company cut the cost of Marlboros by 20% as a price gap had opened up between it and cheaper brands. The shock move tanked its share price by more than a quarter and became known as Marlboro Friday.
Marlboro’s owner hopes the worst may be over. Altria executives point out that the market share of deep discount cigarettes has been stable for three consecutive quarters. But slowing their march has been expensive. Altria is offering promotions to Marlboro smokers to boost volumes. It also launched a cheaper line of cigarettes, Marlboro Black Gold, which accounts for around one-tenth of the Marlboro franchise overall. These moves help, but at the expense of profits.
Major tobacco companies face a delicate balancing act. They need to squeeze as much income as possible from traditional cigarettes so that they can invest in new smokeless products like heated tobacco sticks or oral nicotine pouches that are increasingly the industry’s future.
That task will be much harder so long as cheaper cigarettes and illegal vapes are inhaling their market share.
Write to Carol Ryan at carol.ryan@wsj.com
