The State of E-Cigs; Updates From Industry and Big Tobacco

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,



Howard Penney

Managing Director


Matt Hedrick



Fred Masotta



The cerebral enervation is peaking today after three days of mind-numbing, testimony laden #JuryDuty and an early morning parsing of jobs mania,  so we’re going with the twitter’esque summary update in this week’s earnings scorecard. 


The trifecta of takeaways below sufficiently summarizes the prevailing trends. 



While consumer companies were the notable fundamental laggards in 4Q13, decelerating operating momentum has been pervasive to start 2014. 


At the three-quarter mark,  just 46% and 44% of companies have reported sequential acceleration in sales and earnings growth, respectively. Less than half of SPX constituents have reported sequential operating margin expansion as well. 


Easy forward comps is one way to frame it up for the panglossian-colored glasses contingent, I suppose.   #Weather





BEAT-MISS TRENDS:  The sales beat percentage worsened W/W and, at 52%, is tracking at its lowest percentage since 1Q13.   EPS beats, meanwhile, are tracking at their best level in years as proactive earnings management continues to reward both investors and management teams







THE PRINT:  Fundamental forecasting has mattered for a second consecutive quarter, particularly on the bottom line.  While the correlation between EPS beats and subsequent performance has been equivocal, of the minority of companies that have missed bottom line estimates, 75% have gone on to underperform the market by -3.7% on average over the subsequent 3 trading days. 






Christian B. Drake


McGough: Why I'm Short Target | $TGT

Takeaway: We are short TGT. Here's why.

Hedgeye retail analyst Brian McGough explains why he doesn't like Target (and it has nothing to do with the recent security breach of its credit cardholders).

McGough: Why I'm Short Target | $TGT - TARGET cartoon

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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.

Employment Data: Beyond the Headline Numbers

A strong jobs report this morning indicated a 288,000 gain in employment in April, greater than the 218,000 that economists forecasted.  This marks the largest gain since January 2012.  In addition, unemployment plunged from 6.7 to 6.3% in the month largely due to fewer people entering the labor force.  That last point suggests that the underlying trends may not be as rosy as the headline numbers would indicate.


We received mixed results this morning from the BLS pertaining to restaurant industry employment and we do have a few notable callouts.  The 20-24 YOA cohort had its second lowest month of employment growth since June 2013, which is a bearish data point for quick-service restaurants.  The 45-54 YOA cohort also continued its employment slump, as April marked the 18th consecutive month of employment deterioration.  This is, in our view, a material headwind to casual dining restaurants and is part of the reason that industry is in secular decline.  On the other hand, the 55-64 YOA cohort had its best month of employment growth since July 2013 and is, all told, a bullish data point for the casual dining industry. 


In aggregate, the report was slightly disappointing for the restaurant industry as all age buckets, aside from the 55-64 YOA cohort, reported a sequential decline in employment growth.  With that being said, we continue to favor select fast casual and quick service operators over casual dining operators, despite being bullish on both DRI and BOBE as special situation plays.


April employment growth data:

  • 20-24 YOA: +1.01% YoY; -295.3 bps sequentially
  • 25-34 YOA: +1.80% YoY; -35.8 bps sequentially
  • 35-44 YOA: +0.86% YoY; -27.2 bps sequentially
  • 45-54 YOA: -0.21% YoY; -2.5 bps sequentially
  • 55-64 YOA: +1.98% YoY; +55.0 bps sequentially


Employment Data: Beyond the Headline Numbers - AGE


Despite the sequential decline in employment growth in most age buckets, employment growth across full-service restaurants, limited-service restaurants, and leisure & hospitality continues to grow at a fairly healthy clip.  However, we’d note that employment in limited-service restaurants remains the most robust and caution that growth across all three segments remains well below June 2013 levels.


Employment Data: Beyond the Headline Numbers - yy employment growth


Employment Data: Beyond the Headline Numbers - LEIS AND HOSP



In the chart below, we look at the correlation between TTM Leisure & Hospitality Employment Growth and TTM Knapp Comps.  Historically, Knapp same-store sales have tracked well with employment growth in the leisure & hospitality industry, however, this positive correlation began to break down in mid-2012.  This trend continues, supporting our case that the casual dining industry is in secular decline.  In this type of environment, we continue to believe that only the most nimble and innovative players will thrive.


Employment Data: Beyond the Headline Numbers - KNAPP   FS COMP



Howard Penney

Managing Director


Fred Masotta


Witness the Epic Consensus Head Fake In the 10-Year Treasury This Morning

Takeaway: The bond market showed its immunity to lagging indicators and consensus expectations.

Despite an initial, brief sell-off in 10-year yields following this morning's positive jobs number, the bond market showed its immunity to lagging indicators and consensus expectations.


Witness the Epic Consensus Head Fake In the 10-Year Treasury This Morning - benryan


Ten-year yields are now sitting right on our 2.59% tail line of resistance (down 44 basis points year-to-date.) Keep a very close eye on that.


With the US Dollar on its knees, trading near YTD lows (-0.60%) and inflation ripping into the purchasing power of consumers (CRB Index +9.6% YTD) the bond market continues to support our #GrowthSlowing view.


We’ve been saying this for months now: Inflation is accelerating and growth is slowing. 



THE TELL-TALE HEART: April Employment

SUMMARY:  The establishment report was strong, the household report was weak and earnings growth was middling as the collective two-day takeaway is that growth probably isn’t as bad as yesterday’s GDP report or as strong as today’s headline NFP or Unemployment rate would suggest.  The muddle continues. 


Neither the dollar nor rates are buying into the headline strength and with inflation accelerating (real-time billion prices project says 2.5% inflation, 1950's style survey Core PCE says <1%), housing decelerating, the wealth effect ebbing, income growth not enough to sustainably support the current level of household spending, and consensus growth estimates still too high, we think the call is to stick with the YTD playbook. 


See this morning’s  EARLY LOOK for the strategy breakdown. 


SINCE THE TROUGH:  Here’s the current tally across the various payroll/labor measures since the February 2010 NFP employment trough.  We eclipsed the January 2008 peak in Private employment last month and, at present, are 113K below the prior peak in total NFP employment. 

  • NFP:  +8.6MM
  • Private: +9.2MM
  • Household Survey:  +7.1MM
  • Labor Usage/Job equivalents (Total employed * Hours/wk): +11MM

THE TELL-TALE HEART:  April Employment - Empoyment Summary Table


THE TELL-TALE HEART:  Duration of Current Expansion At 59 months as of April, the current expansion sits exactly at the mean duration of expansions over the last century. 


As we highlighted previously (GREEN SCREEN MACRO) balance sheets recessions are defined by slower recoveries with lower amplitude (& likely longer periods), but the fed, in weighing their policy course, has to be considering the ticking clock (or beating heart to maintain the analogy) and their capacity for dealing with another cyclical downturn.   


THE TELL-TALE HEART:  April Employment - Recession Table April


HOURLY EARNINGS:  Average private hourly earnings growth decelerated -20bps sequentially to +1.9%.  Sub-2% wage growth belies the optical strength in the NFP figure and is not enough to support the current level of household spending.  


The upside for consumption will remain constrained as share of wallet for other discretionary purchasing remains pressured by rising food and energy inflation and soft real wage growth.


THE TELL-TALE HEART:  April Employment - Nominal PCE vs Nominal Earnings April



WHAT IF? The below don’t provide much in the way of practical application, but they do provide some context along with the entertainment value. 


  • What if the Labor Force Participation Rate (LFPR) had remained the same MoM – what would the April Unemployment rate have been?

If population growth is taken as given and YoY growth in total employed as measured by the household survey (where YoY growth has been rather consistent despite the volatility in the absolute MoM figures)  grew at the 3M average of 1.39%, a static participation rate would equate to a 6.85% Unemployment rate for April


  • What if the post-recession employment distribution = pre-recession employment distribution?

The idea that the employment recovery has been largely illusory because we’ve only added low wage and part-time jobs has garnered continued attention. 


Yes, the distribution of employment by industry has shifted, but not tremendously, and while structural unemployment will remain a Trend issue (for a host of reasons), such a shift is a necessary disruption for an economy in selective, secular transition (more energy, more medical, more tech, etc).       


In the scenario analysis below we show actual aggregate earnings (indexed) since the February 2010 employment trough vs. implied aggregate earnings had payroll gains since the trough occurred at the pre-recession employment distribution.  As can be seen, at a cumulative delta of ~25bps, the difference isn’t particularly stark. It's a good narrative though.   


THE TELL-TALE HEART:  April Employment - Aggregate Earnings Scenario Analysis april


THE TELL-TALE HEART:  April Employment - Employment Distributiion april 



INITIAL JOBLESS CLAIMS:  The accelerating improvement in initial jobless claims over the last six weeks was supportive of NFP strength in April as seasonally-adjusted claims were ~15K lower in April (during the employment survey period) and ~40K lower than April of last year. 


Notably, after 5 weeks of accelerating improvement, non-seasonally adjusted jobless claims, which we consider a more accurate representation of the underlying labor market trend, were up 5.1%  in the latest week - compared with down 8.3% in the prior week.


The 4-week rolling average, the better measure, showed a decelerating rate of improvement, moving to -8.2% from -10.9% on a y/y basis.


Source: Hedgeye Financials

THE TELL-TALE HEART:  April Employment - 1 normal  1


THE TELL-TALE HEART:  April Employment - 2 normal  2  


State & Local Government Employment:  State & local government employment growth accelerated for a fourth straight month in April.   At ~17% of both NFP employment and aggregate wage/salary income, the ongoing improvement in state fiscal positions should continue to support both job and government expenditure growth.  


THE TELL-TALE HEART:  April Employment - State   Local Gov t April 


Household Survey:  The Unemployment rate posted its largest sequential decline (-0.4%) since December 2010 as the labor force declined by -806K (-733K Unemployed + -73K Employed) and the LFPR returned to recent trough (down 37bps to 62.81%) trough levels.  


The U-6 rate (12.3%) followed the U-3 rate lower (positive, on balance), declining -40bps sequentially while employment growth decelerated across all age cohorts except 55-64 year olds to start 2Q14


THE TELL-TALE HEART:  April Employment - Unemployment Rate April


THE TELL-TALE HEART:  April Employment - Employment by Age April


THE TELL-TALE HEART:  April Employment - U 6


THE TELL-TALE HEART:  April Employment - CNP vs CES


Enjoy the Weekend,


Christian B. Drake


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