RAI’s Investor Day this morning, while comprehensive in updating the entire portfolio, focused on the launch of its electronic cigarette (e-cig) VUSE. In fact, the majority of questions (~ 12 of 15) asked following prepared remarks (from analysts and the investor community) centered on e-cigs. This further confirms to us that while e-cigs make up a tiny fraction of Big Tobacco’s portfolio (approx. 1%), the interest in and investment behind the e-cig category will remain a major focal point. We expect that investors will overweight e-cig results in gauging broader company performance as expectations continue to ratchet higher that e-cigs can replace declining traditional tobacco volumes (expected to be ~4-5% in 2013).
Position: We remain extremely bullish on the potential growth of the e-cig category. Our preferred Big Tobacco play remains Lorillard (LO), given its leading share in the e-cig category (~50%) and advantaged menthol portfolio.
Highlights of RAI’s presentation section on e-cigs:
- RAI CEO Daan Delen says the consumer migration to smokeless is underway, anchored on:
- Harm reduction awareness; affordable price; enjoyable experience
- Consumers have a wider variety than ever of non combustion offerings:
- Nicotine replacement, dissolvables, snus, moist snuff, and e-cigs
- Delen describes e-cigs as high consumer interest, but low adoption, in a fragmented category, with product quality and performance issues, but poised for substantial growth if consumer expectations (for the overall experience) are met
On the Product (VUSE):
- Rolled out exclusively in the state of Colorado in July
- Expects nationwide distribution by mid-2014
- Seeing strong Awareness (83%), Consideration (68%) and Trial (48%), but exclusive adoption of e-cigs only 1.4%
- Similar demographics (age, gender, ethnicity) and income and education between e-cig users versus traditional cigarette smokers (charts from RAI presentation below)
- Calling VUSE a “Digital Vapor Cigarette”, not an “e-cig”
- Available only in rechargeable format (belief in razor-razorblade model to be margin enhancing over time)
- Packaging design dissimilar to traditional cigs. Has “smart light” at tip to signify when to replace (shuts off after 200 puffs =~ 1 pack of trad. Pack) to ensure quality and signals battery strength
- Selling only single replacement cartridges per pack to mimic traditional smokers who typically buy by the pack (versus 5,10, 15, 20 replacement cartridge pack offered from competitors)
- Assembled in the U.S.A.
- Safety measures around battery and recharging safety
- Treating e-cigs like a tobacco product (in marketing, advertising, and age restrictions)
- In Colorado, VUSE #1 e-cig brand, 60%+ share (said supply could not keep up with demand)
- No definitive plans to move internationally, focused on U.S. rollout first
- On FDA, said company has no idea what deeming regulation could be handed down. Confident that whatever is passed, VUSE will stand ahead of the pack due to its quality control
VUSE and E-cigs in Context:
Note that Altria (MO) also recently issued its own e-cig, MarkTen, in August. Both MO and RAI’s e-cigs distribution lag LO’s purchase of Blu in April 2012. We’re clearly seeing Blu enjoying first-to-market advantage, and taking significant market share in the category (from 40% to 49% in the last quarter alone), albeit on severe promotion and discounting. Given RAI and MO’s entrance, we’d expect more price wars as all try to stoke trialing and achieve brand loyalty.
We continue to see e-cig manufacturers favor the razor-razorblade model of a rechargeable unit and replacement cartridges to disposable e-cigs (the private manufacturer NJOY is one big exception among major distributors), with expectations that they’ll be margin enhancing. However the point on when, given the infancy of the category and desire by manufacturers to increase trialing, remains unanswered.
Another wild card remains when and to what degree the FDA will regulate the e-cig category. The agency was expected to announce regulations last month—the government’s shutdown may or may not have moved the goalposts. It’s anyone’s guess now just when that may happen, however manufacturers continue to expect something before year-end.
It’s our opinion that the FDA wants to protect the consumer, while not stifle e-cig innovation that can ultimately lead people away from the harmful combustible cigarettes. A few of the larger regulations expected to be addressed are online sales, flavors, and marketing, however regulations could go much further. It appears the science on e-cigs remains incomplete, which would suggest to us that the agency may err on the side of less regulation versus more regulation until the science is (more) conclusive.