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Having cleared Q1 earnings from the Big Tobacco companies we follow (LO, RAI, MO, PM) and given the FDA’s release last week of proposed regulation, it’s time to re-assess the e-cigarette landscape: what’s developing at the industry and company level, and what are the biggest takeaways?


***We want to make note that in the coming weeks we will be doing an e-cigarette and e-vapor survey. We hope to better understand consumer adoption trends, brand and product type preference, and user profile.  We look forward to bringing you the results.***

  • Brand Leaders: LO’s blu continues to maintain dominance of the c-store channel at ~44% dollar share followed by LOGIC (~22%) and NJOY (14%). Dollar share trends since the beginning of 2013 demonstrate steady growth for LOGIC, steady decline for NJOY, and after expeditious growth in 1H13 a flattened share since August 2013 for blu. The XAOC data shows a slightly different lineup, but lead by blu (45%), followed by FIN Brand (Victory) (16%); Ballantyne Brands 14%, and NJOY falls to the 4th position at 10%.
  • Pricing and Volume Dynamics Weaken: Across most brands we’ve seen volume and price tapper off since mid-2013 based on a number of factors: (i) monster year-ago comparisons, (ii) introduction and flooding of the market with new kits from existing manufacturers alongside RAI and MO beginning to launch nationwide, and (iii) severe discounting and promotion within a competitive environment, engaged at driving trial (of new product) and winning brand loyalty. E-cigarette sales growth slowed to ~ 5% in April compared to ~ 150% in 2013.  As we’ll hit on in more detail below, we think the weakness in the category is also a reflection of the rise of larger vaporizers (sold at vapor shops) that are not being counted by industry scanner data (more on vaporizers below).
  • The proposed regulation from the FDA was surprisingly light: NO proposal to ban e-cig flavors; NO move to restrict the marketing of e-cigarettes; and NO proposal to ban online sales. (For more see FDA Finally Proposes E-Cigarette Regulations - They’re Surprisingly Mild!). Our work with most major e-cigarette manufacturers (including the private companies of NJOY, Ballantyne Brands, LOGIC, and Victory) suggested they were expecting even more “deeming” regulations. We suggest that the rather lax proposed regulations should serve to support investment behind the industry, from Big Tobacco to the hundreds of independent (and smaller) manufacturers, given the latter can leverage online sales and flavors. (Note: MO, RAI, LOGIC and NJOY only sell e-cigs in traditional tobacco and menthol flavors).
  • Q2 2014 will usher in intense competition: RAI and MO will be launching their e-cig brands, Vuse and MarkTen, respectively, on a national level after success in initial test market states. They’ll attempt to claw back on LO’s share leadership with blu. We expect consolidation in the industry as all of U.S. Big Tobacco ramps its e-cig distribution, however the pace of consolidation may be slower given the FDA’s favorable (regulation mild) stance on the existing industry.
  • Commentary that larger vaporizers (tank/pens/mods/open systems/etc.) are taking share from “tradition” format e-cigs like blu: LO CEO Murray Kessler said he believes vaporizers -- sold primarily at vape shops -- are taking some share from blu and other “traditional” style e-cig players (the format Big Tobacco is using today), because the products deliver a better experience at a lower price point. Although he was quick to note that this e-vapor format comes with regulatory challenges – in fact reading the tea leaves we think Kessler was betting the FDA was going to put more prohibitive measures on this format and e-vapor juice. Because the FDA largely didn’t touch non-traditional vaporizers and e-vapor juice, Kessler was quick to counter that LO is considering the landscape, and was suggestive that though the current traditional e-cig is the company’s format of choice, his team is currently working on devises that deliver superior vapor and battery life to close what may be a widening sales gap with vaporizers, etc. He expects these improvements to be rolled out over the next 6 months, and to hit the market piece by piece, rather than a giant roll out (similar to how new razor blades come out for the same razor). As noted, we’ll be doing survey work in the coming weeks to better understand the trends of non-traditional e-cig usage.
  • Category enthusiasm not shared by all: in the Q1 Big Tobacco conference calls we noticed a discernible difference in commentary about the quality and experience of an e-cig compared to a traditional cigarette. LO noted that larger vaporizers are better meeting the consumer’s desires, and along with MO, and RAI expressed a very bullish opinion about the direction of the technological improvements to better the experience. PM struck a much more cautious tone and said the flavor satisfaction is not there and underlines that while new product launches received great growth and enthusiasm, usage trends were quick to moderate. PM’s less than rosy tone comes as a surprise, given last year it announced it would accelerate the launch of an e-cig product to mid-2014, instead of a previous target of 2016/17, at a cost of $100MM, and then announced a  €500MM investment to build a manufacturing facility in Italy for Reduced Risk Products (RRPs), which include e-cigs.
  • Common Threads: Big Tobacco is excited to participate in the category, focused on investment behind it, and believes its ability to deliver rapid technological innovation can propel the category forward.  blu was by far the loudest in describing its strategy as RAI and MO are just now commencing nation distribution. We suspect that RAI and MO will take a similar tack to LO in their willingness to sell e-cigs at break-even or a slight loss over the near-term to gain/solidify market share, with the expectations for e-cigs to be a strong profitable growth business that enjoys margins at or above traditional tobacco. All are uncertain on just how the FDA will regulate e-cigs in the future, but agree that these proposed regulations are likely step one in a longer (hopefully science-based) approach to better understand e-cigs.

 

To underline how lax the proposed e-cigarette regulations were compared to expectations, below are three quotes from leading manufacturers:

  • Murray Kessler, CEO of Lorillard, owner of blu: "It appears that the FDA is taking a science-based approach, and that the proposed rule itself defines a constructive process that recognizes that e-cigarettes are different than combustible cigarettes.  Despite what I am sure will be a robust give-and-take process over the comings months, we remain committed to our belief that electronic cigarettes represent a major opportunity to align the interests of business and public health.  We look forward to working collaboratively with the FDA through the notice-and-comment rulemaking process to devise a reasonable, scientifically-based regulatory framework covering e-cigarettes."
  • Craig Weiss, President and CEO of NJOY: “By resisting calls to regulate ahead of – and indeed in opposition to – the science and data, [today] the FDA has brought NJOY a giant step closer to achieving its corporate mission of obsolescing cigarettes.”
  • Miguel Martin, President of LOGIC: “I would say that there were certain people that went into this thinking the FDA would be a foe — an irrational, illogical opponent to these devices…[But] they’ve hit the ball right down the middle of the fairway. It is early, I might change opinion, but the original set up on the process seems extremely fair.”

Have a pleasant weekend vaping,

Matt

Howard Penney

Managing Director

Matt Hedrick

Associate

Fred Masotta

Analyst