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.