• run with the bulls

    get your first month

    of hedgeye free


What’s Big Tobacco Saying About E-Cigs in 3Q13?

For a second straight quarter there was significant buzz around Big Tobacco’s electronic cigarette offerings.  While LO remains ahead of the pack through its acquisition of Blu in early 2012, both MO and RAI joined the category through test market launches in individual states in Q3, and PM reaffirmed its plan to launch an e-cig in 2016/7.


A big surprise in the quarter was Blu’s market share gain to 49% vs 40% last quarter, on sales growth of +11% sequentially and +350% year-over-year  to $63MM in the quarter. This growth was driven squarely on severe discounting and couponing, resulting in break-even cost for the company, confirming CEO Kessler’s goal to forgo short-term profits for long term gains.  LO’s decision to buy SKYCIG in early October (2013), a three year old UK based e-cig maker with ~300,000 users that has mimicked Blu’s product packaging design, provides LO with an international platform, albeit with a much smaller size, scale, or relationship of Blu in the U.S.  LO’s estimated the “fragmented” UK market to be worth an estimated $300MM in 2013 and hinted that it would assess opportunities to scale across the EU down the road.


Much of the commentary from management in the quarter centered around the uncertainty of the FDA’s pending regulation on e-cigs.


We’re very pleased to further the e-cig discussion in an expert call with Craig Weiss, CEO of NJOY, this Wednesday (10/30) at 1pm EST.  NJOY, a private company, is a leading e-cig manufacturer of traditional tobacco and menthol offerings that are sold nationwide in 70,000 stores.  Email me () or , if you’d like to join the call.



LO:  it’s clear CEO Murray Kessler’s e-cig strategy is to forgo short-term profits for long term gains. The company sold its new rechargeable starter kits (they began shipping in Q2) for break-even in the quarter, which increased its retail market share to 49% vs 40% last quarter!  With $63MM of e-cig sales (vs $14MM in the year-ago quarter  and $57MM last quarter), Blu earned a gross profit of $15MM with SG&A of $15MM to net operating profit of $0.  From Kessler’s comments, it appears that this break-even strategy could be expected for at least the next two quarters as LO attempts to boost awareness, trialing, and repeat purchasing of Blu. Other takeaways include:

  • Kessler reiterated forecast for 2013 e-cig sales to be worth around $1-2B at retail; no hard estimate for online.
  • Expects e-cigs to have a 1% impact on total cigarette category in 2013.
  • Believes that the deciding factor on how big the category can be is what comes out on the regulatory environment.
  • If there is reasonable regulation that allows for marketing and advertising, it has already been proven that the e-cigs category can drive strong repeat purchasing.
  • While technology will get better over time, it is not the deciding factor.
  • If the FDA is overly strict, just like cigarettes requiring substantial equivalence, the category will grow more slowly.
  • Quarterly product mix (in dollars): Disposables 47%; Cartomizers 27%; and Kits 26%.
  • In the quarter they saw the amount of rechargeable kits sold up dramatically compared to old format (discounted price also clearly driving purchases).
  • Blu now in 127,000 retail outlets.
  • Expects strong margins down the road for the company and retailers.
  • UK Market: estimated at $300MM with no clear leader. Could be another $1B market, but depends on the regulatory market – so far so good.
  • Believes SKYCIG acquisition expands its global presence, although it will not have a roll-out or growth curve like Blu in the U.S. given the lack of retail relationships and sales force.
  • Kessler contextualized the purchase of SKYCIG acquisition as a one-off, with plans to grow organically if it were to expand its reach across the EU.
  • Optimistic that the UK Parliament endorsed e-cigs for their harm reduction and has moved it away from being regulated as a medicinal product. 
  •  In the UK, the company can advertise e-cigs on TV, until at least 2016, but advertising regulations vary across EU countries.
  • On UK and EU Rollout – there has been no decision to roll out SKYCIGs to the rest of Europe. Has intention for Blu to become a global brand. Bullish that SKYCIG already has the same packaging as Blu (essentially they copied Blu from inception), and now is focused on increasing the sales force of SKYCIG. 


MO:  brought its e-cig brand MarkTen to the marketplace in August (to 3,000 retail stores) in its first test market in Indiana, which CEO Marty Barrington described as a very successful launch with good product feedback and consumer insight.  The company announced plans to increase its spend on MarkTen in Q4 and to distribute to 2,000 stores in Arizona. 


Marty suggested it was too early to talk about the performance on MarkTen. He said they are seeing dual use, as some adult smokers try e-vapor, but results are inconclusive.  On the category he said that while it has grown very quickly off low base, it is unclear if it can sustain this growth level. And in similar fashion to the reporting from Big Tobacco, he stressed that as products get better and more acceptable, he’d expect greater transition, but much depends on how they’re regulated by the FDA – heavy regulation would certainly not encourage adoption. 


He also said it was too early to tell if e-cigs will cannibalize smokeless or estimate the share they could take from traditional cigarettes.



RAI:  If you don’t think e-cigs matter to big tobacco – think again!  On the earnings call, the progress on VUSE, the company’s first e-cig that was launched in July in the test market of Colorado, was the first brand that management reviewed. CEO Delen said that VUSE is getting a great reception with leading market position in the state (we’d expect so given the strong couponing). He noted strong repeat purchasing and that its replacement cartridge was the largest selling SKU, and believes that VUSE can attain cigarette-like margins over the medium term. Further information on its plans around a national roll-out were indicated to come at next month’s Investor Day meeting.


Delen indicated that he has no further information on when the FDA may come out with a ruling on e-cigs (expected October timeline) and/or if the government shutdown will delay the announcement. He did note that RAI engaged with the FDA on VUSE, and the meeting was heavily attended by the FDA.


Given that Colorado is a test market, it’s hard to extrapolate the costs for a nationwide roll-out – certainly it’s a competitive category and RAI is playing slightly behind the 8-ball.  We look forward to monitoring VUSE’s performance.   



PM:  CFO Olczak is positive on the EU Tobacco Directive as it relates to regulating e-cigs as tobacco products and not as medical devices.  He reiterated that PM is working on a few alternative products (including an e-cig) that are slated for full commercialization in 2016-17. With regards to PM being late to the E-cig show, Olczak said that most e-cig makers now focus much of their attention on marketing, and less on the product, and PM’s focused on going to market with the right product, not about being the first mover.


While we think next generation products will turn more attention to product development to mimicking even closer a traditional cigarette, we would be concerned that PM’s big tobacco rivals and a few select private players also have significant budgets and R&D underway to bring better e-cig products to the market (and perhaps sooner than PM’s extended timeline). The caveat here is that as regulatory frameworks around e-cigs evolve globally, the landscape, and players involved, are subject to change.



Matthew Hedrick



Title: Expert Call with the CFO of EAT

Speakers: Howard Penney, Hedgeye Risk Management; Guy Constant, Brinker International

Subscriber Link: CLICK HERE 



Industry-Wide Insight

  • The evolution of the casual dining industry
  • How Brinker adapted to these secular changes
  • The future of the casual dining industry
  • The difficulty in operating nine different brands
  • The whittling down of the company
  • The birth of operational efficiency
  • The evolution of the value proposition

Brinker-Specific Insight

  • Leveraging technology to drive traffic
  • Future technological initiatives
  • The development of the delivery business
  • Better executing on pizza and flatbreads
  • The Mexican food opportunity
  • The current reimaging initiative




Guy Constant: “It’s been an interesting time since 2006, when the industry, in our view, in the late 2000s entered into a mature phase.  The industry being casual dining, in this case, entered into a mature phase and how we reacted to that initially and how we’ve reacted to it since has been an interesting journey for our company.  But since, really, late 2009, early 2010, when we realized that the historic way that we had operated and been successful and had won in casual dining had changed, and we thought permanently, and continue to believe permanently, we realized there was a different way we need to compete and operate in this business. 


And so, for us, that meant focusing on our core Chili’s business, improving our business model and preparing for an environment where we felt in the future would result in a lower comp sales environment for casual dining, lower demand for the consumer going forward.  And so, that’s the journey we’ve really been on, it started with us stopping growth of our restaurant concepts. 


It followed very quickly with the pairing down of our portfolio from what was as high as nine brands in the mid-2000s all the way down to two brands today, that being Chili’s and Maggiano’s, followed very quickly by an aggressive effort from us to improve margins in the Chili’s business, which had deteriorated pretty dramatically from the early 2000s to the late 2000s, really with average annual volumes that were very similar when you looked at those two periods.  Margins at Chili’s, in particular, we’re down over 600 bps if you compare 2010 to 2002, again at similar unit volumes.  So we knew there was opportunity to turn the margins of the business around and do what, really, every company, every manufacturing company in America has done over the past 20 years.”




Guy Constant: “I think what can happen, at least what happened in our business, I certainly can’t discuss what happened in other businesses, but certainly in our business, with particularly Chili’s being so much larger than all of the other brands that we’ve had historically, was that if you were to look at the 20 best ideas for improving the Chili’s business, number 20 on that list was always worth more money than number 1 on the list of any of the smaller brands. 


And so, you were faced with this quandary that the best idea to improve one of our other brands, which you’d want to pay a lot of attention to since it was such a good idea, still wasn’t worth as much as an idea that was well down the list at Chili’s.   So, it could get easy to have the Chili’s part of the business say, “Why are you working on the smaller brands when there is so much opportunity at Chili’s?” and it would be very easy to be at the smaller brand and say, “You’re obviously either trying to turn us into Chili’s or all of your focus is on Chili’s and you’re not paying enough attention to us.” 


And so, over time, while we’re sitting in the middle of that, you could never really point to gosh the extra brands are distracting or they’re impacting our business, the end result was that you could see it in the results of the overall business that we weren’t performing as well as we should.  Is it a coincidence that we moved our portfolio down now to two brands, that our results got better?  Maybe.  But I actually think there is some correlation there to the ability to focus solely on Chili’s, which has always been the best part, and the most profitable part, of our business, and leverage that as best we could in order to compete in this new environment.”







How difficult was it to manage all 9 brands?

  • Characterize it is as the “impasse of brain space”
  • You end up paying more attention to the larger brands and the smaller brands are unable to fulfill their potential
  • Performance suffers
  • Think there is a correlation between moving the portfolio down to two brands and generating stronger returns

What technological initiatives have you undertaken in order to drive traffic?

  • In regard to kitchen and manufacturing technology, they are in the 6th inning; certainly more to be done, but they have made strong progress already
  • In regard to front of the house operations, they are in the 1st or 2nd inning
  • The primary differentiator in the casual dining industry is service
  • Technology allows businesses to enhance service
  • Fast casual is so attractive, because it is extremely convenient
  • Companies must figure out how to leverage technology in order to enhance convenience

What are the primary advantages of the tabletop technology?

  • It is an opportunity to enhance service
  • It allows for more convenience, by allowing the customer to control when to pay and leave the restaurant
  • There is an average check improvement
  • Tends to drive sales around beverages, desserts, and add-ons
  • Allows for useful feedback from guests
  • Allows the company to expand their database and leverage it through customer relationship marketing activities

How has the value proposition evolved over time?

  • Value proposition was broken from 2005-2006
  • Brinker, and casual dining as a whole, had low and declining value scores
  • By 2006, there was a wide gap between the prices of QSRs and casual dining companies
  • Fast casual filled this gap, which is one reason they have been so successful
  • Casual dining companies need to focus on investing in quality food and menu innovation

What potential do you see in the delivery side of the business?

  • Delivery is currently 10% of business, despite being poorly executed
  • Delivery orders typically fill the gaps between peak hours
  • There is a large amount of upside
  • Execution was holding them back
  • Cutting down the menu and linking up with kitchen technology in order to give accurate cook times will help drive the business and enhance the overall operation

How can you better execute on pizza and flatbreads?

  • There is an opportunity to drive incremental traffic from loyal guests by increasing frequency of visits or driving their ticket up
  • They need to do a better job marketing to non-loyal, newer school type customers
  • Made a commitment to invest slightly more in media

How will Mexican contribute to sales?

  • Mexican will be an innovative message from them, more so than a value message
  • Have tested all the items
  • Need to make a few, low cost adjustments in their kitchens in order to ensure operational execution is top notch

How far along are you in the remodeling process?

  • Have 50-65% of the system done; plan to have 75% done by June
  • Should be done with all of the company reimages by the end of FY14 or the end of 1Q15
  • Finished remodels in California around 6-9 months ago
  • Have seen very good results from these remodels
  • Still need to remodel most of Florida and part of Texas
  • Capex will come down significantly as the remodeling program unwinds




Howard Penney

Managing Director








investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.


  • At the end of September, there were 10,250 VGT’s up and running, up 9% (833 units) MoM
    • Since the market opened last September, average monthly installations have trended at 849 units
  • Using an average of the machines outstanding at the end of August and September, average daily win per device was $100/day in the month of September, in-line with the average for the last 3 months.  As the chart below shows, despite recent added supply, daily win day has remained steady around the $100 level.
  • As of October 24, there were still 1,554 establishments pending approval.  If approved, these establishments can add a maximum of an additional ~7,770 machines.  This implies a market size of roughly 18-20,000 VLTs, unless Chicago opts in.  At the current pace of installations, we expect shipments to IL to taper off materially by the summer of 2014.
  • Supplier impact:              
    • IGT has been shipping about 1,000/ Q to IL which translate to about 5 cents a year of EPS impact
    • During the last 2 quarters, BYI’s shipped 1,369 to IL and 1,943 units over the last twelve months.  An additional 2,000 VGT unit shipment to IL should translate to about $0.25 cents in earnings for BYI.


[video] Keith's Macro Notebook 10/28: VIX, GOLD, UST 10YR


In preparation for NCLH's F3Q 2013 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.






  • Norwegian Getaway, is getting ready for her debut in Miami early next year.


  • Looking at deployment for the third quarter, our capacity in each itinerary is as follows. Our Europe program has 28% in the Mediterranean and 8% in the Baltic. We have approximately 20% each in Alaska and Bermuda, 13% in the Caribbean, 7% in Hawaii, and the balance made up of other itinerary.


  • I would say that we've had some promotional activities going on following that. And when I look at it right now, I would say that things in the last few weeks seem to have been a little bit better. And I think some of the noise as well is – some of the players may be doing a little bit more from a promotional standpoint to fill up their ships.  Having said that, what I'm seeing now is that will play out over the remainder of this year.


  • Onboard, we have a great quarter – some of it is Breakaway, some of it is just the continuing efforts we have. I would tell you that the remainder of the year is built into our forecasted guidance and yields...But it is a little lumpy.


  • We've been able to bottom out in Europe market with yields and we're starting to see the ticket yields improving. But there are a few more Europeans on the ships than what has been the trend.
  • On the margin, we're seeing a bit more of the Americans, but we're also seeing quite a few – and you look at the European economic situation, you're getting a little bit of a later booking from some of these countries. And we're all fighting for the same number of consumers. So in some cases, you're getting people that are spending a little bit less from the European side.


  • We're feeling pretty decent about what's going on for next year, although it's early. We're feeling pretty good about the booking patterns for 2014. First quarter, we're feeling very good about both on the load and the price.


  • My preference would probably be given where we are, it would probably to be in the stock repurchase program.


get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

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.