Big Tobacco takes its last drag

Economic shifts in the industry merit investors' attention as the price elasticity of the cigarette industry changes.

By TheStreet Staff Sep 6, 2013 12:53PM

thestreet logoMan smoking (© Steve Mason/Photodisc Blue/Getty Images)By Antoine Gara


Investors addicted to dividend-paying cigarette stocks such as Philip Morris  (PM), Altria (MO), Reynolds American (RAI) and Lorillard (LO) may have to kick their habit.


Cigarettes are known in economic circles as an inelastic product. Because they are highly addictive, their demand doesn't vary with economic change and hence large tobacco conglomerates have little incentive to alter their pricing. The dividend paying industry benefits from a product with a low price elasticity, a term coined by Alfred Marshall, the founder of modern economics.


In fact, cigarette pricing is so steady tobacco is excluded in most surveys of inflation. Now, amid the rise of smokeless tobacco and the electronic cigarette, some on Wall Street are beginning to worry that the tobacco industry has lost some of its deadly economic force.


Cigarette price elasticity has deteriorated sharply in recent years among the Big Three U.S. manufacturers, according to a survey published by Citigroup on Thursday.


"While the U.S. cigarette manufacturers continue to assert that cigarette price elasticity has remained relatively stable over the last 20 years, our math indicates that price elasticity in U.S. cigarettes has in fact deteriorated notably over the last decade," Citigroup analysts wrote.


The long-term price elasticity of the cigarette industry has ranged from -0.3 to -0.4 in 10-year averages. However, Citigroup found that price elasticity in the U.S. was -0.8 in 2012, a dramatic change. The falling stickiness of cigarette pricing is all the more troubling as consumption trends signal a long-documented decline in the U.S.


Citigroup cited rising promotions for cigarettes, smoking restrictions in the U.S. and new substitutes such as smokeless cigarettes as reasons for the fundamental economic shift of the industry.


The analysts believe the earnings profiles of Altria and Reynolds American are relatively insulated from a continued deterioration in the fundamentals of the cigarette industry given their exposure to smokeless tobacco. Lorillard, which generates nearly 100% of its earnings from cigarette products, could be more at risk.


All is not lost for investors who aren't in a rush to kick their addiction to Big Tobacco's juicy dividends and their stable share prices through the economic tumult of recent years.


The price premium of Altria-owned Marlboro, the leading cigarette brand by market share in the U.S., has increased relative to Copenhagen, the second largest chewing tobacco brand in the U.S, over the past four years. As cigarette consumption falls by mid-single digits annually, smokeless tobaccos have seen a proportionate amount of growth.


In comes a new economic term for Big Tobacco investors to chew over: the cross elasticity of demand.


Basically, people need their fix whether or not politicians allow smoking in bars, offices, athletic venues and state land.


As consumption and pricing of cigarettes face structural economic change, smokeless tobacco products such as chew and its Swedish iteration, Snus, are direct beneficiaries. Those segments of the market are seeing growth and the prospect of margin expansion.


"We believe that attention should be paid to the deteriorating price elasticities in U.S. cigarettes. However, we don't think it's yet cause for alarm, given the still-wide gaps that exist between the margins for smokeable tobacco offerings," Citigroup noted.


E-cigarettes, however, could undermine the cross elasticities that Big Tobacco firms enjoy between traditional cigarettes and smokeless tobacco. "[We] do not believe that e-cigarettes are yet having an impact on the longer-term interaction between traditional cigarettes and MST [Moist Smokeless Tobacco], but over time we do not rule out that possibility," Citigroup concludes.


A quick note to consider alongside Citigroup's compelling analysis: Many of the economic shifts they have tracked appear to be a consequence of changing legislation such as smoking restrictions and some states' adoption of extremely burdensome taxes.


Changing political winds could continue to cut against Big Tobacco. Consider that it was only about 10-months ago that states such as Washington, California and Colorado voted to legalize marijuana, a previously illegal product. The prospect of a groundswell of support for the legalization of marijuana nationally could further undermine both the price elasticities and the cross elasticities that have been a staple of Big Tobacco for decades.



More from

Sep 6, 2013 3:16PM
It appears that the one thing not mentioned in the article is the massive growth of tobacco product use in the far east, particularly Russia, China, India, Malaysia and the African continent. All of the major American tobacco companies have invested heavily in those areas with manufacturing and distribution infrastructure. Such moves will all but guarantee their long term profit imperative despite slowing growth in the U.S due to domestic laws, sanctions, and various competing 'smokeless' cigarette products.
Sep 6, 2013 3:46PM
all the tobacco companies are also invested in many others products, their scruples will guide them to profits, they are not on their last drag!
Sep 6, 2013 3:37PM
The true  cause and effect are truly a double-edged sword. BIG TOBACCO, is also  BIG TAX REVENUE!
 Taxes can very anyway between $2-$6 per pack depending on geographic location.
 The federal government will care about the results when they notice the kitty is short.
 There are certain programs that  rely on this tax to provide services such as healthcare and educational programs. There is much more to this to meets the eye.
 When this revenue is lost they will make it up in other areas.  ""SMOKELESS PRODUCTS""
Sep 6, 2013 7:46PM
It did not occur to any of this Staff Report that Big Tobacco could also transition into Big Marijuana if that trend would grow in the future? Really?
Sep 6, 2013 4:47PM

I'll take my/our chances with the different positions in 3 Tobacco Companies...

Dividends are sweet, and I think we are playing with their monies now...

Because I do trade occasionally.


Puff away, me Matey's....Shades of Fatty. 

Sep 7, 2013 12:05PM
The writer didn't do their homework. Lorillard owns Blu, the number 1 ecigarette.
Sep 6, 2013 5:36PM
Legalize pot and big tobacco will get a boost.
Sep 8, 2013 12:35PM
I just checked Altria this AM and they increased their dividend 9% this week.Tthe end? Not quite so near. :)
Sep 8, 2013 4:59PM
There are approx. 300m people in the U.S. There are what, 8 or 9 BILLION people in the world, today. Those other areas barely have an EPA. Last drag? Hardly!
Sep 8, 2013 10:13AM

Big Tobacco, has paid and paid and paid....Taxes to or for Government Entities, mostly paid by the smokers; Tobacco has and use to provide thousands of jobs and farmers with a decent living.

They have paid off Lawsuits, probably more then any other industry..

The Governments used and squandered the money, when the premise was to provide healthcare;

For people with smoking related problems, and cessation products for others trying to quit.


Through tobacco investments, we realize about $3800-4000 in dividends per year; I do not see that declining in the near future, but increasing instead; Which has been a past practice.

Big tobacco will adjust to smokeless products, e-smoke and other associated products to maintain their presence, plus they could move all operations away from U.S. shores..

Once again the Americans losing a viable industry, to a business friendly competitor.


Sep 6, 2013 3:27PM
Smoking 2 packs a day here in Florida costs $5,000 a year.  In NJ it's about $8,000 a year and in NY it's about $10,000 a year.

There is no list of ingredients on a pack of cigarettes.  Yeah, I know you don't eat cigarettes, but you don't eat shampoo either, and there's a list of ingredients on every shampoo bottle.

Because you've switched to an e-cigarette, you can't assume you can use it anywhere.  You must respect private property rights first.
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