- The Washington Times - Wednesday, April 16, 2014

Electronic cigarettes and marijuana could prove a vital breath of fresh air for the nation’s fading tobacco industry.

Desperate for new products and new customers as social and legal attitudes toward cigarette smoking have changed in recent decades, e-cigarettes and legal pot could be throwing a lifeline to Big Tobacco, which already boasts the marketing expertise and regulatory savvy to take advantage of the opportunity.

“Bottom line, the long-held investor perception of tobacco as a sunset industry is wrong,” said David Sealy, senior equity research analyst at the Boston Co. and author of an analysis released Wednesday of the changes sweeping the industry.

The major tobacco companies, including RJ Reynolds, Lorillard and Altria Group, the parent company of Philip Morris USA, are poised to benefit from these “potential game-changers for the growth-challenged tobacco industry.”

The new products and market opportunities are arriving just in time, Mr. Sealy said, as its core cigarette business slowly declines.

“It’s only a matter of time before it goes away,” he said.

Mr. Sealy said it is no longer an industry that rolls tobacco, but an industry that provides nicotine.

Discussion over the saving powers of e-cigarettes and marijuana to the tobacco industry comes at a time when industry officials, investors and consumers are watching what regulations, if any, the Food and Drug Administration will place on e-cigarettes.

With regulations in mind, the report says the $3 billion e-cigarette market is only going to grow and become more of a substantial player in the tobacco industry. The legalization of marijuana will become an option for tobacco companies as well.

“Quantifying the exact change will depend on regulator response, but anyone not thinking about these related opportunities will miss an inflection in one of the world’s largest and oldest consumer businesses,” Mr. Sealy said in the report.

Moving away from nicotine, The Boston Co. report brings another debated drug into the picture as a viable product to sustain tobacco industries: marijuana.

Sixteen states have decriminalized marijuana use, 20 states have allowed medical marijuana use and Colorado and Washington have fully legalized marijuana use. Mr. Sealy said these trends, plus polling that cites 58 percent of Americans support marijuana legalization, signal “snowballing” to move toward national legalization.

“The momentum behind marijuana legalization has not been lost on the marketplace. To date, the market has focused mostly on speculative small caps, but if legalization becomes official federal policy, Big Tobacco will end up dominating the marijuana market,” he said in the report.

But the focus of a savior to the tobacco industry remains on e-cigarettes.

E-cigarettes started with small entrepreneurial businesses that often sell over the Internet, but Big Tobacco, or the handful of major tobacco companies, are ready to capitalize on the device that delivers nicotine through vapor.

One of these top tobacco companies, Lorillard, has developed Blu eCigs, a brand of e-cigarettes that boasts 50 percent of the U.S. e-cigarette market. In the company’s 2013 annual financial report, net sales increased by 4.9 percent because of an increase in both traditional and electronic cigarettes.

Lorillard’s traditional cigarettes such as Newport and Maverick increased in net sales by $158 million. The net sales of their e-cigarettes increased even more, by $169 million.

But not all analysts and tobacco companies are encouraged by the e-cigarette craze. A report out this week by Moody’s Investors Service said e-cigarettes will not have a significant impact on the tobacco industry in the next couple of years because the product makes up only 1 percent to 2 percent of the total U.S. tobacco market.

“Despite the excitement about the category and its extraordinary growth, we believe that the earnings contribution will be quite modest over the near term,” said Nancy Meadows, vice president and senior analyst of Moody’s Investors Service corporate finance group.

Other tobacco companies are more in line with Ms. Meadows’ thinking. According to the 2013 annual financial report, Altria, the parent company to Philip Morris USA, reported a 0.6 percent decrease in net revenue, citing lower revenue of smokeable products as the source.

The maker of Marlboros reported that its domestic-cigarette shipment volume was down 4 percent, “primarily due to the industry’s rate of decline, changes in trade inventories and other factors, partially offset by retail share gains.”

Although the cigarette industry’s volume has decreased, the revenue has remained flat with some small fluctuations. Ms. Meadows said the addictive nature of nicotine keeps the demand steady.

“Tobacco has traditionally a very low price elasticity for demand, which means it’s easier to raise prices without risking a decline in demand,” she said.

The results of whether the e-cigarette will carry the tobacco industry may be a long time coming, but one thing is for sure: Big Tobacco will be reaping the benefits. Accustomed to regulations and taxes for their traditional cigarettes, major tobacco companies are experienced in selling a product surrounding by barriers. If regulations stop Internet sales of e-cigarettes and marketing is cut, the small businesses that pushed e-cigarettes into the market no longer will be able to compete with major tobacco companies.

“It would take sustained growth over years for it to have any meaningful impact on credit metrics of U.S. tobacco companies,” Ms. Meadows said.