E-Cigs Take the $tage

Takeaway: A summary of our conference call with electronic cigarette maker and Ballantyne Brands CEO John J. Wiesehan, Jr.

This note was originally published June 20, 2013 at 16:25 in Consumer Staples

Yesterday (6/19) we hosted a call on electronic cigarettes titled “e-Cigs: The Untapped Market for Electronic Cigarettes”, featuring John J. Wiesehan, Jr., CEO of the Charlotte based company, Ballantyne Brands. (Presentation: CLICK HERE ; Podcast: CLICK HERE)


E-Cigs Take the $tage - cigs


On the call John provided an overview of his company, makers of the Mistic e-cig brand, and offered up some valuable industry insights, which we have included in summary form below.  


We are very bullish on the evolving e-cig category. There has been a rapid pace of innovation, which, along with increased marketing and distribution, is bringing significant awareness to the category. We believe e-cigs offer a compelling alternative to traditional cigarettes and offer a consumer a much different experience than a nicotine patch or gum. The involvement of Big Tobacco (RAI, LO, MO) in the category should continue to lend credibility to e-cigs and accelerate growth; we expect e-cigs to be margin-enhancing to the combined cigarette category for Big Tobacco and 2014 to be a breakout year for them, having tested the waters (through acquisition and mix) through 2013.


The runway for e-cig converters is huge globally:  in America alone, nearly one in five American adults smoke. We expect pending regulation from the FDA to deem e-cigs a tobacco product, and that the regulation could come down harder on online sales, and we expect that the taxation of the product will remain only at the state level. Finally, we believe e-cigs consumption will continue to benefit from its significant price point advantage over traditional cigarettes which will help to grow repeat purchase behavior. 


We think e-cigs is an exciting category with investible potential. For investors looking for a publically traded pure play on e-cigs there is one option, Vapor Corp (VPCO).



On the Category, Industry’s Size, and the Players:

John J. Wiesehan, Jr. is very bullish on the industry. Some analysts have suggested that over the next decade e-cigs could be as big as tobacco is today, a $90 billion industry. He estimates that sales in the U.S. were $150MM in 2011; $500MM in 2012 ($300MM across retail channels and $200MM over the internet); and are projected to be around $1-2B in 2013.


He thinks it is very positive that Big Tobacco has entered the market because it brings credibility (and marketing support) to the category, especially to retailers that will realize the category is not going away due to the backing of Big Tobacco.  He also views regulation from the Federal government (FDA) and regulation on a state-by-state basis as positive for the category.


Despite the involvement of Big Tobacco in the category, John thinks there is plenty of room for non-Big Tobacco players, like a Ballantyne Brands or NJOY.


[Note: Lorillard (LO) acquired e-cig maker Blu Ecigs in April 2012; Altria (MO) will launch its first e-cig under the MarkTen brand in August 2013; and Reynold American (RAI) has the Vuse e-cig].



On Retail Distribution, the Products, and Market Data:

Ballantyne Brands has a national footprint that distributes Mistic e-cigs  across Grocery stores, Drug stores, the Mass Channel, and Convenience stores.  The company notes that disposables sell well at convenience stores, whereas rechargables sell better across their other channels.


The company is focused on product quality, first and foremost the liquid that produces the vapor, insuring that it is consistent and safe.  The liquid is composed of four main ingredients: water, nicotine, propylene glycol (a bonding agent), and tobacco flavoring (traditional or menthol) -- making it an attractive substitute versus the some 4,000 to 7,000 ingredients in a traditional cigarette. None of its products are patented, however, there are some Chinese patents on the hardware that they assemble for the company. [Note: given the existing pace of innovation versus the long time frame for patent approval and desire to protect IP, most e-cig brands have not patented their products].


The company offers two different variations of e-cigs under the Mistic brand, a rechargeable and disposable. For the rechargeable option, customers buy an initial starter kit, which contains 2 cartridges with a MSRP of $14.99, and then buy replacement cartridges as needed (a box of 5 cartridges has a MSRP of $14.99).  John suggests each cartridge is equivalent to approximately two packs of traditional cigarettes.


Replacement cartridges come in traditional and menthol flavors, with 4 levels of nicotine respectively, including a zero percent nicotine level for both flavors. The company does not have any flavors (like coffee, vanilla, pina colada, chocolate, etc.), and markets strictly to tobacco users as an alternative product to traditional tobacco products; in John’s words, “The company is not in the business of recruiting new nicotine users.”


For the disposable e-cig, labeled under the MisticBlack brand (and available in Traditional or Menthol flavors), customers buy a pack of soft tip e-cigs that they dispose of after one use; they have the look, feel and size of traditional cigarettes.  [MisticBlack has a MSRP of $5.99 and will be on the market in July in places such as Wal-Mart.]


The company’s hope is to convert a MisticBlack user to a rechargeable user.  The rechargeable e-cig is in line with the razor, razor-blade model, and is a higher margin business than the disposable for the company and the retailer.  John suggests the gross margin for disposables is in the 40’s (%) for the company and that rechargeable e-cigs are north of that figure, considering the consumer already purchased the battery in a starter kit. 


After the consumer buys the start-up kit John thinks the conversion rate for rechargables will be high (more data supporting this claim is pending), while he thinks converting the disposable user (back to a disposable) will be at a lower rate. 


Mistic brands ranks #3 behind NJOY and BLU in terms of Sales Dollars and Sales Units (according to Nielsen data ended 3/16/13 that does not include internet sales). Importanly, Mistic has been able to holds its share with an average retail price at or above most of its competitors, which John attributes to its high marks on taste and marketing campaigns.



On the FDA, Regulation, and Clinical Studies:

The company believes its products will be treated as a tobacco product in a pending  FDA announcement. On regulations, John admits that it is unclear where the FDA will shake out on e-cigs.   He thinks that regulation is likely to be based on nicotine level, and speculates that a cap could be put in place. Further, the sale of e-cigs could be regulated differently on such factors as internet sales versus retail sales and tobacco flavor vs menthol and other flavors.


John expected an announcement from the FDA back in April. His team now figures that an announcement could be imminent to later this summer.


He notes, today there is no talk of the Federal government issuing an excise tax on e-cigs, but rather expects any taxes will be determined on a state-by-state basis. To date, there are only two states issuing a tax, Minnesota and Oklahoma. In Minnesota, 70% of the cost of goods is taxed, which retailers pass fully onto the consumer. In Oklahoma, e-cigs are taxed at 5% based on liquid content. For Mistic, that translates to a 5 cent tax on a pack of disposables and 25 cent tax on one package of cartridge refills (5 cartridges to one pack). The company is generally comfortable with the Oklahoma tax structure, and it believes that its value proposition over traditional cigarettes will remain a huge tailwind to consumer demand.


To date, there is no clinical study that the FDA recognizes supporting that e-cigs are less harmful than traditional cigarettes.  There are however many independent studies in which the results show that e-cigs are less harmful. He thinks that common sense would indicate that a product with 4 ingredients verses 4,000 that is not burned to consume is a “healthier” alternative, however it’s premature to speculate on how the FDA will rule on e-cigs. The company is pushing hard with its lobbyist in Washington, D.C. that the FDA suggests e-cigs are less harmful than traditional cigarettes.


On Value Proposition and Consumer Appeal:

An average cost of a carton of traditional cigarettes in the U.S. is $60. In comparison, a 5 cartridge replacement pack of Mistic, which is equivalent to a carton of cigarettes, has a MSRP of $14.99. [The company also has a 10pack with a MSRP of $24.99].


John argues that they are not marketing their products to stop smoking, but simply as an alternative to traditional smoking, and nothing else.  However, testimonials do suggests that consumers are using the products to reduce consumption of traditional cigarettes. John believes the consumer’s appeal to an e-cig, versus a nicotine patch or gum, is that that an e-cig satisfies four main desires of smokers: hand to mouth; inhale something and get a kick in the throat; exhale something (a vapor simulates smoke); and the taste of the nicotine (without the burning sensation of a traditional cigarette).


That is to say, with other products like a nicotine patch or gum, the consumer is really not getting a cigarette substitute, just the nicotine.



On Advertising and Restrictions:


The company launched the “Easy Choice” advertising campaign back in April 2013. It is 100% all print, including USA Today and WSJ, targeting 15-20 key metropolitan areas where distribution is strong. The company has chosen to be compliant with the advertising restrictions of tobacco companies, so it does not advertise on television or on billboards. 


It is also focused on age restrictions, and is a member of the WE Card Manufacturing Advisory Council, which forces anyone under the age of 18 at a retail store to be carded.



On International Involvement:

Ballantyne Brands is looking to Europe and Asia for distribution. There are, however, countries in which they are not allowed to sell into, including: China, Canada, Australia, and Brazil. John notes that some parts of Asia are “open”, while some are not.


In Europe, the UK will be a major focus.  A recent decision from the UK’s version of the FDA is to regulate e-cigs as medicines by 2016. The company is broadly comfortable with the regulation because it won’t take its product off the market, ban it, and any implementation of the regulation won’t come until 2016. The company believes that the regulation will fall on the level of nicotine in e-cigs, to make sure it is consistent with traditional cigarettes, which Ballantyne Brands believes it should have no problem complying with. 




Stay tuned as we continue to do work on the electronic cigarette space.


Matthew Hedrick

Senior Analyst

Morning Reads on Our Radar Screen

Takeaway: A quick look at stories on Hedgeye's radar screen.

Keith McCullough – CEO

Gold Slips to 34-Month Low (via Bloomberg)

Violence in China's Xinjiang 'kills 27' (via BBC)

Picture (for those too politically polarized to see #GrowthAccelerating) (via Hedgeye)


Morning Reads on Our Radar Screen - radar


Jay Van Sciver – Industrials

For those who want to know why FedEx Ground has been taking share for over a decade (via


Darius Dale - Macro

The 5 Happiest Countries (DD note: Interesting analysis on what makes people happy across the developed world; US is not even in the Top-10 .. video via Marketwatch)


Howard Penney - Restaurants

McDonald's rang cops on disabled woman in Taiwan (via Herald Sun)


Josh Steiner – Financials

Think It's a Level Playing Field in the Financial Sector? Think Again. (via Bespoke)


Jonathan Casteleyn – Financials

Biggest Banks’ Wind-Down Plans Seen Failing to Cut Risks (JC note: Balkanization or local banking rules are creating lots of noise and in the end will shrink assets but raise ROEs …  via Bloomberg)


Matt Hedrick – Macro

No Government No Problem as Czechs Unfazed by Instability (via Bloomberg)

Turkey to Romania Seen at Risk as Emerging-Market Inflows Slump (via Bloomberg)

Got Growth Right?

Client Talking Points


The Weimar Nikkei is really starting to underperform now. It doesn’t even go up on dead cat bounce days in China or Europe. The Nikkei was down another 1% overnight and is down -17.8% since May 22. It remains well below our 13,683 TREND line of resistance. #Ugly.


The crash in Gold continues after both US Durable Goods and New Home Sales showed that Bernanke needs to taper. That of course was the May data; our models suggest that April - June may be the top in sequential US #GrowthAccelerating. That said, we remain data dependent on this. Go ahead and ask Gold (down -4% this morning and a monster -27% YTD) how US growth is doing. I'm sure he'll tell you it's doing just fine. #Nasty


Can you spell R-I-P? 2.59% last on the 10-yr. Folks, there is no immediate-term TRADE resistance to 2.69%. Velocity and volume here matters. The simple speed of the move, combined with the most bond outflows since October 2008 is not a buy signal for bonds. That whining you're hearing in the distance is bond bulls begging for Bernanke.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Financials sector head Josh Steiner is the Street’s head bull on residential mortgage originator/servicer Nationstar, projecting $9 in earnings for the company in 2014.  This is well above the company’s own guidance range, which tops out at around $7.50. NSM had a successful start to the year as it won servicing bids on substantial mortgage portfolios.  They also reported significant increases in their profit margins on those portfolios, and double-digit increases in their own originations.  Housing prices are ramping significantly higher, as Steiner predicted, as demand continues to exceed supply in both new and existing homes.  Steiner says this quality mortgage company could ride the crest of a sustained wave of sector improvement.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

Three for the Road


Who the hell signs off on a central planner telling you what he "intends" a market price to do? @federalreserve

@KeithMcCullough (responding to a Fed President's statement on CNBC that the bond market reaction was outsized versus the Fed's intentions).


“Many men go fishing all of their lives without knowing it is not fish they are after.” -Thoreau


About $60 billion has been wiped from the value of precious metals exchange-traded product holdings this year. (Bloomberg)


Enter your email address to receive our newsletter of 5 trending market topics. VIEW SAMPLE

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.

Are Staples Cheap Enough?

Valuation alone is never a catalyst in our investment process; however below we updated charts on forward P/Es of the consumer staples sector and its main sub sectors.


Needless to say, while valuations have come in over the last two months, they remain stretched, and cheap alone (think CPB or TAP) is not a signal for us to buy. At 17.5x, the consumer staples P/E is just under a two standard deviation move, and compares to an average of 14.5x over the last 5.5 years.


Of note is that sub sectors of HPC and Beverage have come in the most over the last ten days, yet all sub sectors are priced well over one standard deviation.


Our quantitative real-time set-up for consumer staples (etf: XLP) is bullish, trading above its intermediate term TREND line of $38.71, and we would buy it (cheaper) closer to this level. 


Are Staples Cheap Enough? - ww. 1


Are Staples Cheap Enough? - ww.2


Are Staples Cheap Enough? - ww. 3


Are Staples Cheap Enough? - ww. 4


Are Staples Cheap Enough? - ww. 5


Are Staples Cheap Enough? - ww. 6


Are Staples Cheap Enough? - ww. 7


Are Staples Cheap Enough? - ww. 8


Matthew Hedrick

Senior Analyst

Uncertain China

“Nothing is certain but the unforeseen.”

-J.A. Froude


No stranger to intellectual debate, British author James Anthony Froude (1) was well-known for stirring the pot – perhaps even more so than @HedgeyeDJ (Daryl Jones, our no-holds-barred DoR) and @HedgeyeENERGY (Kevin Kaiser, our oft-controversial senior energy analyst).


Froude’s generally polemic works were often met with fierce debate and rejection among the British intellectual elite – perhaps none more so than his seminal work The Nemesis of Faith (1849), which was carefully crafted to call into question blind acceptance of the popular Christian doctrine of the time. Widespread public backlash in response to the novel ultimately cost Froude his fellowship at Oxford University.


Eventually Froude’s avoidance of institutionalized groupthink won out. Froude and his wildly contentious ideas ultimately found a permanent home when he was appointed Regius Professor of Modern History at Oxford (i.e. a really big deal) in 1892 – the very institution he was driven away from nearly a half-century prior.  During his regrettably brief stint at Oxford (he died in 1894), Froude quickly earned a reputation for being among the most popular lecturers of his time.


If nothing else, Froude’s journey from the top to the bottom and back again is a lesson for analysts young and old to avoid the safety and comfort of groupthink. Never is this advice more important than when a time-tested, comprehensive and repeatable research process leads one to hold a counter-consensus view. Hold the LINE [short], Kaiser!


Back to the Global Macro Grind


Incorporating another one of Froude’s lessons, we call attention to the aforementioned quote in the context of China’s banking system woes – which, thanks to the recent spate of legacy media coverage, are now as obviously present as a 6’3”, 325lb left tackle in one of Froude’s 19th century lectures.


Specifically, anyone even tangentially following recent press will arrive at the conclusion that a growing consensus among analysts across both the buy and sell sides believes with a fair amount of certainty that China’s credit binge and alleged housing bubble are sure to cause a Western-style financial crisis.


We aren’t so sure. With less than 2% of all financial assets held by foreigners, strict capital controls have, thus far, prevented a mass exodus of liquidity through the capital account. Domestically speaking, the PBoC’s own words from yesterday should douse any hopes of a crisis:


“Financial institutions’ cash reserves stood at about 1.5 trillion yuan ($244 billion) as of June 21, compared with the 600 billion yuan or 700 billion yuan sufficient under normal circumstances to cover payment and clearing needs. The present liquidity is not insufficient.”


Indeed, by comparing China’s present-day banking woes to the early tremors of Bears Sterns or juxtaposing China’s property market – rife with “ghost cities” – with our own pre-crisis froth, consensus has undeniably fallen victim to the availability heuristic. We don’t think that’s a prudent call to make at the current juncture; the Chinese sovereign has the resources, political will and mobility to prevent any Western-style financial crisis.


We’ve become a broken record on this, but it’s critical to remember that China’s present day economic woes are actually a function of very deliberate macroprudential policies. While highly unlikely, at any given time, Chinese officials can reverse course and keep the credit bubble inflating longer than any of us short-sellers can remain solvent.


On the contrary [to consensus], we think the outlook for China’s banking sector is likely to resemble that of a slow bleed, rather than sudden cardiac death. We’ve published a ton of work recently backing our conclusions with detailed analyses, but for those of you who weren’t able to tune in until now, we’ll take this opportunity to rehash our views:

  • Alas, it remains our view that the headwinds facing China’s banking system are structural (i.e. NOT cyclical) in nature.

Please email us if you’re interested in reviewing the full compendium presentation materials and research notes backing these conclusions, and we’ll get them right over to you. We also have a list of ancillary securities and asset classes to underweight/sell/short if you’re interested in those as well.


At any rate, we urge you to embrace the uncertainty of this situation by running full speed away from anyone who tells you they know how this all ends.


In fact, the only certainly anyone can promise you regarding these risks is that the outcome is presently unforeseen and, quite possibly, hidden deep within the “shadows” of China’s financial sector.


Our immediate-term TRADE Risk Ranges are now (TREND bullish or bearish in brackets):


UST 10yr Yield 2.35-2.69% (bullish)

SPX 1 (bearish)

DAX 7 (bearish)

Nikkei 12,406-13,449 (bearish)


VIX 16.59-20.98 (bullish)

USD 82.21-83.39 (bullish)

Euro 1.30-1.32 (neutral)

Yen 96.25-99.17 (bearish)


Oil 99.18-103.39 (bearish)

NatGas 3.64-3.82 (bearish)

Gold 1 (bearish)

Copper 2.98-3.12 (bearish)


Keep your head on a swivel,



Darius Dale

Senior Analyst


Uncertain China - Chart of the Day


Uncertain China - Virtual Portfolio

real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.