Follow the youth, as the old saying goes, in investing. If you can predict the trends of the younger demographic, then you can make big returns.
One thing you don’t see a lot of is the younger demographic picking up a cigarette. While traditional cigarette demand is falling and poised to keep falling, electronic cigarette demand is rapidly increasing.
I wrote a piece on why cigarette makers will eventually have to cut their dividends as cigarette demand has fallen from 640 billion cigarettes in 1981 to 293 billion in 2011, while payout ratios remain high. But perhaps Big Tobacco might be able to use electronic cigarettes to find growth in a perpetually-declining market.
According to the CDC, the number of high school students who ever used e-cigs rose to 10% of the population (1.8 million) from 4.7% in 2011. This is an increase of over 900,000 customers. While that doesn’t mean that all of these customers are buying multiple e-cigs each year, it does show that interest in the product is rising.
As far as the more consistent consumer goes, the number of high school kids who used e-cigs in the past 30 days rose from 1.5% in 2011 to 2.8% in 2012. This means teenage consumers are starting to use e-cigs more often. 75% of all e-cig smokers also smoke traditional cigarettes, but that still leaves 25% of e-cig users who don’t smoke traditional cigarettes. This means that consumers who are normally put off by the bad health effects of traditional cigarettes are warming up to vaporized nicotine.
Tobacco companies like Altria Group Inc (NYSE:MO), Lorillard Inc. (NYSE:LO), and Reynolds American, Inc. (NYSE:RAI) are all trying to get into this emerging market. As of right now e-cig sales are predicted to hit $1 billion by the end of 2013. By 2018, an analyst at Wells Fargo said sales could reach $10 billion .
While sales of $1 billion in 2013 still pales in comparison to the $100 billion traditional tobacco market, if this market could reach $10 billion then whichever company is able to effectively capture the most market share will be able to offset declining cigarette sales.
Altria Group Inc (NYSE:MO), the maker of Marlboro cigarettes, recently announced it was making MarkTen e-cigs. While MarkTen sales started in August only in Indiana, I expect Altria will group out distribution over the next few months.
Lorillard Inc. (NYSE:LO), the maker of Newports and Mavericks, bought out the e-cig maker Blu Ecigs in 2012 for $135 million. Blu e-cigs are very popular and currently take up 40% of the market . If the market increases to $10 billion a year, then Lorillard would make $4 billion a year in revenue from its $135 million acquisition, which would be quite the return on investment.
E-cigs represent an enormous growth opportunity, since Lorillard Inc. (NYSE:LO) made $6.6 billion in revenue in 2012. If the market grows to a multi-billion dollar industry, then even with the decline of traditional cigarettes, Lorillard will be well-positioned to substitute cash flows.
Reynolds American, Inc. (NYSE:RAI), maker of the Camel brand, has launched an electronic cigarette under the brand name VUSE. When Reynolds announced this product, it said it would be a “game changer” and a margin enhancer. If electronic cigarettes reach volumes that will push up margins, then you don’t necessarily need to recover all of the lost revenue from the decline of traditional cigarettes.
Out of these 3 companies, Lorillard Inc. (NYSE:LO) is leading the pack by far. Its acquisition of Blu Ecig clearly has the potential to pay off big time, especially since it gave Lorillard 40% of a soon-to-be $1 billion market.
Altria Group Inc (NYSE:MO) may dominate the traditional cigarette market with close to 50% market share, but it needs to leverage that popularity to really start selling more MarkTen e-cigs. The release in Indiana is probably to test the waters, to see how the company can modify the product to best suit national demand. Once Altria is done, it should start aggressively marketing MarkTen, because it is already far behind.